GROWTH STRATEGIES IN A GLOBAL ECONOMY

THE LAUDER GLOBAL BUSINESS INSIGHT REPORT 2016
GROWTH STRATEGIES IN
A GLOBAL ECONOMY
INTRODUCTION
THE LAUDER GLOBAL BUSINESS INSIGHT REPORT 2016
GROWTH STRATEGIES IN A GLOBAL ECONOMY
As nations continue to emerge from the Great Recession, they face similar challenges in the
effort to rebuild and strengthen their economies. But successful transformation does not come
without growing pains: As they look to what worked in the past, businesses and governments
face the future knowing that some things must change — whether that means embracing new
technologies, shoring up inadequate infrastructure or borrowing ideas from different cultures.
In this special report, students from the Joseph H. Lauder Institute of Management &
International Studies offer unique perspectives gleaned from interviews, observation and
research into the struggle for self-improvement by nations.
In Tunisia, government officials and business owners are trying to draw a new kind of tourist
who is willing to wander away from the all-inclusive beach resorts to explore the country’s
rich history and culture. In Brazil, the world’s second-largest producer of ethanol, significant
technological advances present an opportunity to adapt new, more efficient production
methods. Japan is pushing itself away from traditional attitudes about money to develop a
stronger private equity market. And in Colombia, high fashion is rapidly rising as a star of the
economy, ready to give Paris and Milan a run for the money.
From a small shift to a sea change, transformation is taking place around the world. Some countries
will win; others won’t be so successful. But for those who persevere, the payoff will be big.
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
CONTENTS
GROWING AN ECONOMY: HOW NATIONS BUILD THEIR BASELINE
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6
10
14
18
22
25
28
33
Tunisia’s Tourism Strategy Shifts from Sand and Sea to Culture
The Global Push for Talent Development
Colombia’s Fashion Industry Moves Forward
Rio 2016: Winning the Olympics Bid
The Chinese Investor: Monolith or Mosaic?
Getting to Scale: Colombian Startups Look to International Growth
The Flower Industry in Colombia: Current Trends and Challenges
The Global Oil Industry and Africa’s Role in Its Future
Colombia’s Informal Sector
SOMETHING DIFFERENT: TECHNOLOGY CHANGES EVERYTHING
37
41
45
Second-generation Ethanol Production in Brazil: A Historic Opportunity
How the U.S. and China Each Nurture Innovation
Back to the Future? Germany’s Evolving Startup Scene
HELP OR HINDRANCE: WHY INFRASTRUCTURE IS IMPORTANT
48
53
57
Transportation Infrastructure Development in Asia: A Comparison of Indonesia, Vietnam
and China
Favelas: Brazil’s Lingering Infrastructure Problem
Living in the Shadows: How Rural Workers Pose a Challenge to Chinese Urbanization
NEW TRADITIONS: WHEN CULTURE CLASHES WITH PROGRESS
61
65
69
74
78
82
86
90
Why the Organic Food Industry in China Hasn’t Taken Off
The Social, Political and Economic Impact of Chai in India
Entrepreneurship and the Custo Brasil
A Nation Apart: The Development of Private Equity in Japan
Breakfast in China: How 1.4 Billion People Start Their Day
Le Gaspillage Alimentaire: Stopping Food Waste in Europe
Female Entrepreneurship in China: Women Hold up Half the Sky
The State of the Arts: Realities and Implications of France’s Cultural Subsidy System
Growth Strategies in a Global Economy
1
HOW NATIONS BUILD THEIR BASELINE
Tunisia’s Tourism Strategy Shifts from Sand and Sea
to Culture
In a quest to reinvigorate its economy, Tunisia has embarked on a new strategy focusing on
cultural tourism to showcase the country’s rich and significant historical resources.
Tourism has played a central role in Tunisia’s economy since
the country attained independence from France in 1956,
and while packaged tourism remains vital to the sector, a
new emphasis on cultural and heritage-inspired tourism has
evolved. After independence, President Habib Bourguiba
aimed to position Tunisia as an open country that was
receptive to the West in order to achieve progress and
prosperity. He was generally successful, and by the time he
was ousted in 1987, his rule was recognized for its support
of women’s rights, social development, openness to the
West and receptiveness to foreign investment and tourism.
When tourism became an essential component of the
government’s development strategy in the 1960s, Tunisia
focused on appealing to a mass audience through packaged
tourism. Approximately 80% of this activity catered to
large tour groups. To accommodate the primarily Northern
European demand for low-cost resort tourism along
the coastline, the government invested in major hotel
construction projects along the coast during the 1960s
and 1970s. In 1980, the country hosted 1.5 million tourists
who contributed about 7% of the GDP. While investment in
the sector has grown — for instance, private investment in
Tunisian hotels amounted to TD 10.5 million ($4.5 million)
2
in 1977 but grew to over TD 299.5 million ($486.6 million)
by 2013 — the share of the GDP has remained stable over
the years, amounting to 7.3% in 2013. While most of the
hotels are located in the capital city of Tunis, about 80% of
the bed capacity is found in the resort areas lining the coast.
The Challenges of Packaged Tourism
But packaged tourism poses several challenges for a
country such as Tunisia. First, it is characterized by
permissiveness, tolerance and limited cross-cultural
understanding and communication. Tunisia accommodates
this type of tourism but attempts to isolate it from the
mainstream population by constructing resort enclaves
along the Mediterranean coast, where European values
supercede those of the local residents. When tourists
interact with Tunisians, it is rarely spontaneous and often
contrived.
Second, Tunisia experiences an average annual rainfall of
1.3 inches and has only one flowing river. As a result, there
is much competition between the agricultural and tourism
sectors over water. The average per capita rate of water
consumption in tourist enclaves is more than eight times
greater than in the rest of the country. The water supply
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is cut off intermittently in some parts of some cities, yet
residents observe hotel staff watering gardens and filling
swimming pools from a seemingly unlimited supply.
Furthermore, massive private debt within the tourism
sector has resulted in limited spending on renovations and
operations and has caused a downward spiral in both the
quality and prices of hotel rooms, leading to stagnation in
employment and revenues. Many hotel owners have also
stopped paying off their debts, enabling them to undercut
prices and hurt the profitability of the better-performing
hotels. This has accelerated the decline in revenues and
posed further problems for the sector.
A Shift in Strategy
In the early 1980s, Tunisia experienced a decline in
tourism receipts driven by the second global oil shock and
protectionist measures in Europe. As a result, the country
found itself in the precarious position of being vulnerable
to Europe’s economic decline, the economic instability in
the Arab world and a decline in demand for mass beach
tourism. Soon after Zine El Abidine Ben Ali became
president in 1987, he formed the Ministry of Tourism and
Handicrafts to reshape and diversify the tourism strategy
in response to these external factors and their potential
widespread impact on Tunisia’s economy. The country’s
focus on mass beach tourism and offering international
tour operators an inexpensive Mediterranean destination
left it with an image as a place for a cheap beach vacation.
To attract a wider variety of tourists, it would need to grow
its cultural- and heritage-based tourism.
Even as the government implemented initiatives to
diversify the sector, Tunisia has continued to attract
primarily those drawn by packaged tourism. The small
segment of culturally inspired tourists had not motivated
the government to devote significant time or resources
to heritage preservation or museum development.
For example, work to restore the Punic and Roman
archaeological site of Carthage did not begin until the late
1990s. While tourists often visited the capital of Tunis as
part of their packaged vacations and would visit the ruins of
Carthage, the ancient medina, the town of Sidi Bou Said and
the National Bardo museum, they usually quickly moved on
to other locations along the coast.
Growth Strategies in a Global Economy
During Ben Ali’s rule, Tunisia showcased its greater concern
for its cultural heritage by empowering groups such as
the Association de Sauvegarde de la Medina de Tunis
(Association for the Protection of the Medina of Tunisia),
which was awarded outside funding for conservation
projects in the medina of Tunis. In addition, in 1997 the
government created the Agence de Mise en Valeur du
Patrimoine et de Promotion Culturelle (Agency for the
Development of National Heritage and Cultural Promotion)
to enhance archaeological sites for tourism development.
Packaged tourism poses several
challenges for a country such as
Tunisia. First, it is characterized by
permissiveness, tolerance and limited
cross-cultural understanding and
communication.
The goals behind these initiatives were to not only expand
the tourism sector and attract a type of tourist who would
produce higher revenues, but also to shift some of the
tourism incomes to inland cities and expand opportunities
for craftsmen, artists and tour guides. To achieve these
aims, the government expanded its spending on cultural
affairs to over 1% of its total budget. This funding
allowed for the construction of a new national library, the
restoration of old museums, the opening of new museums
and the introduction of exhibitions and festivals. While
helping to shape the country’s new tourism image, this
spending also created a greater awareness of and interest
in Tunisians’ own cultural-heritage education. These
values and goals were amplified after the Arab Spring, the
democratic uprising that resulted in the removal of Ben Ali
from office in 2011 and ushered in heightened feelings of
empowerment, opportunity and nationalism.
The Preservation of the Medina
The project to preserve the medina of Tunis has not only
inspired greater cultural awareness and interest among
Tunisians but has also driven increased tourist interest in
the country’s cultural heritage.
3
In 1979, UNESCO designated the medina of Tunis as a
World Heritage Site along with other districts in the Middle
Eastern cities of Damascus, Syria, and Cairo, Egypt. But the
medina of Tunis differs from other Arab old towns in that
it has remained sheltered from global influences. Instead
of selling real estate to foreign investors, the town and its
preservation efforts serve an important identity role for
Tunisians. To a great extent, those involved in the project
are local and national and value the medina’s symbolic
significance.
The revitalization and preservation efforts are designed
to brand the medina as a cultural asset so it does not
become a dead museum or exclusively a tourist attraction
and to ensure no part of it is sold to foreigners. Unlike
revitalization efforts seen in other medinas in the Arab
world, the efforts in Tunis aim to attract local residents
and limit mass tourism. Instead, through the revitalization
projects, culture-oriented tourism will attract individual
travelers.
By controlling and regulating the
real-estate market, the government
can ensure that the medina of Tunis
will not be influenced entirely by
European residents.
By controlling and regulating the real estate market, the
government can ensure that the medina of Tunis will not
be influenced entirely by European residents. Currently,
foreigners must obtain permission from the governor
in order to purchase real estate in Tunisia, a long and
complicated process that can extend over many years.
This bureaucracy has discouraged foreign investors
and has prevented a sell-out such as that seen in the
Moroccan city of Marrakesh. Rather, officials seeking to
encourage Tunisians to move into the medina have been
offering incentives to homeowners to help them with their
restoration projects.
Today, the medina of Tunis has become a shopping
destination during the day and a place to meet, dine
and stroll in the evening. Given the medina’s symbolic
4
significance during Ramadan — a holy month of fasting
and spiritual renewal for Muslims — residents of Tunis
are drawn to the many concerts and events hosted as part
of the Festival de la Medina. TV shows, especially those
broadcast during Ramadan, serve an important role in
showcasing the area. The buildings and narrow streets of
the town serve as a stage and backdrop for many of the
programs and thus encourage greater appreciation among
Tunisians and an increase in the number of visitors.
Heritage Preservation as a Social
Movement
During Ben Ali’s presidency, the tourism sector was
controlled largely by those well connected to the regime.
One of the most pronounced changes since the Arab Spring
is the greater opportunity for new players to invest in the
sector, with many of their investments focusing on smallscale developments with heritage in mind. However, as
noted by Leila Ben Gacem, who owns the boutique hotel
Dar Ben Gacem in the Tunis medina and works with the
Association de Sauvegarde de la Medina de Tunis, the
ecosystem for cultural tourism is still developing and
much of the responsibility for its growth falls on social
organizations such as Carthagina, a nongovernmental
organization formed in 2013 to preserve and promote the
heritage and history of Tunis. Since the revolution, Ben
Gacem said, there has been an increase in the number of
curious and socially interested tourists who want to learn
more about Tunisian heritage and culture. The difficulty
is in meeting their needs, given the limited number of
professional tour guides and cultural initiatives.
In addition, much of the medina remains in disrepair. While
some Tunisians have been inspired to invest in real estate
there to open coffee shops, small hotels or restaurants,
the return on their investment has been very slow. Across
the medina’s 670 acres, there are only 10 boutique hotels,
including Ben Gacem’s. She borrowed money to buy a
historic courtyard home and spent four years restoring it.
Even though her hotel is often fully booked and she can
price her rooms at boutique prices, she laughingly says
that it will take her 50 years to recoup her investment. She
operates a formally licensed boutique hotel and thus pays
monthly taxes of TD 1,000 ($500) and TD 3,000 ($1,500)
in salaries for her employees. This high tax rate actually
encourages many hotel owners to go unlicensed. Of the
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10 such hotels in the medina, only two are licensed. As
the project to preserve the area is ongoing and is largely
a social initiative on the part of Tunisians, it relies on
the growing support for cultural and heritage education
initiatives.
events are often at full capacity. By fostering appreciation,
interest and recognition of the value of cultural and
heritage sites, Carthagina and similar organizations can
help funnel money into those preservation projects that
Carthagina serves as a prime example of this symbiotic
relationship. It benefits from Ben Gacem’s patronage,
hosting some of its meetings at Dar Ben Gacem. At the
same time, it is one of those organizations responsible for
helping to shape the cultural ecosystem that Ben Garcem
says is central for those tourists attracted to the medina.
Unlike revitalization efforts seen in
other medinas in the Arab world, the
efforts in Tunis aim to attract local
residents and limit mass tourism.
There is a growing desire among Tunisians to learn
more about their heritage, and Carthagina caters to this
interest. Since its inception, Carthagina has hosted a
number of lectures and tours at various sites all across
Tunisia. It brings historians and archaeologists together
with interested citizens at sites where posted signage and
information are limited.
may encourage growth in culturally oriented tourism.
However, as Carthagina’s co-founder Emna Mizouni points
out, “we cannot talk about tourism if we are not talking
about how to identify ourselves.”
From visits to the Roman ruins of Carthage and Dougga in
northern Tunisia to learning about the olive oil industry, the
Growth Strategies in a Global Economy
This article was written by Hoda El-Ghazaly, member of the
Lauder Class of 2017.
5
The Global Push for Talent Development
When the public education system fails to graduate students with the skills needed to enter the
workforce, many private companies are shouldering the responsibility of getting those young
recruits ready for duty.
Throughout the world, there is a critical inadequacy within
traditional state education systems to develop enough
workers with skills relevant to the modern economy. This
has resulted in a push by corporations to remedy this skill
shortage through initiatives to train and educate both
blue-collar and white-collar workers. The solutions range
from simple internal training programs to customized
partnerships with local technical schools, externships
at competitor companies and even the development of
accredited, affiliated educational institutions. It is clear
that, with some ingenuity, companies are increasingly
able to take control of developing their most important
commodity and tap into the vast global pools of
underutilized human capital.
The educational structure in
Germany places a heavy emphasis
on industry-academia ties, so it is
notable that BMW has had success
in replicating its workforce-training
model for its operation in the United
States.
South Carolina: Importing a German Model
of Skills Training
German automaker BMW has partnered with local
universities around Spartanburg, South Carolina, to
establish a two-year apprenticeship program for highschool graduates. Each graduate studies at the institution
while working 20 hours a week at the BMW plant in
Spartanburg. At the end of the program, for which BMW
covers tuition costs, the student receives an associate’s
degree and has the option to join BMW full time or pursue a
four-year degree at a university.
6
This model provides more experience and knowledge
about BMW than a typical two-month summer internship
would, and it enables students to learn critical skills that
are in high demand and short supply in the workforce. If a
student decides to join BMW after graduation (most take
advantage of this opportunity), the company benefits from
a new employee with highly relevant skills who is already
engaged in the company’s culture.
This unique form of training has traditionally helped
German companies leapfrog over their competitors in the
areas of innovation, efficiency and quality. The educational
structure in Germany places a heavy emphasis on industryacademia ties, so it is notable that BMW has had success in
replicating its workforce-training model for its operation in
the United States.
China’s Drive for Global Expertise
China’s entry into the World Trade Organization (WTO) in
2001 resulted in an increasing demand for global talent.
The “Go Out Policy,” in which the government encourages
enterprises to invest abroad, further increases pressure
on employers to seek talented employees who not only
understand the local market, but also have international
exposure and global vision.
As a number of managers in China have pointed out, the
country suffers from an acute talent gap. According to a
September 2013 article in China Daily, “China needs 75,000
executive managers with global experience in the next five
to 10 years, but there are only 3,000 to 5,000 people in
the local market who meet the necessary criteria.” There
are several reasons for this shortage in talent. First, the
vast majority of Chinese have never traveled abroad.
Statistics show that only 3% of the Chinese population own
passports. Second, most mid-to-senior Chinese executives
born before 1985 did not receive an overseas education.
And many Chinese who are overseas are not familiar with
the local market and lack local connections.
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Many state-owned enterprises (SOEs) and private
companies have developed their own training initiatives
to address the problem. Sinopec Corporation, one of the
top three petrochemical SOEs in China, established a
Management Institute in Beijing to provide executives with
local knowledge and global exposure. The company, which
is a quasi-governmental organization, is actively seeking
overseas expansion and acquisitions. Yet it has difficulty
hiring overseas due to salary and cultural issues. The
Management Institute provides in-house English lessons
and international business, leadership, communication
and management courses for mid-level employees. In
addition, it has established partnerships with the world’s
top business schools (Wharton, Harvard Business School
and INSEAD) and regularly sends its employees to
different locations for training, including at multinational
competitors’ oil firms. These overseas experiences have
enhanced Sinopec’s employees’ intercultural skills and
helped the company better integrate into the global
environment.
Despite offering lucrative compensation packages,
Hillhouse, one of the best-performing investment funds in
China, also faces a talent shortage. Given its stellar track
record and reputation, it has successfully attracted top
talent from around the world. However, most of its staff has
spent a significant part of their lives and careers abroad and
are unfamiliar with the mindset of Chinese entrepreneurs.
Hillhouse recently established an intensive training
boot camp in which new hires meet for three weeks to
conduct case studies and research projects on China’s
latest telecommunications, media and technology (TMT)
investment trends. The program is mentored by highcaliber entrepreneurs such as Pony Ma of Tencent, Richard
Liu of JD.com and Robin Li of Baidu. This training initiative
has proven effective in boosting foreign employees’
understanding of Chinese markets.
The Chinese government also sees an increasing need to
introduce global talent into the economy and is working to
complement private training initiatives. It has developed
the Recruit Program of Global Experts (1,000 Talent Plan)
to recruit expatriate experts — primarily strategic scientists
and internationalized innovative teams — to promote what
have been identified as “seven strategic industries.” Many
companies focused on research and development, such as
Growth Strategies in a Global Economy
Huawei, Goldwind and Mindray, are key beneficiaries of
this program.
Vietnam: Bridging Local Skill Shortages
Vietnam is viewed as one of Asia’s most attractive foreign
investment destinations. Since joining the WTO in 2007,
the country has prospered and shown a consistent growth
rate of more than 5%, second only to China’s in the region.
But the situation was very different two decades ago.
Unemployment rates were high, job opportunities for
college graduates were scarce and there was a huge divide
between the skills potential employers were seeking in
graduates and those that educational institutions were
training them in. A number of companies, including
Glass Egg Digital Media and ISA TanTec, have done an
outstanding job in bridging this skills gap.
The Chinese government also sees
an increasing need to introduce
global talent into the economy and
is working to complement private
training initiatives.
Glass Egg Digital Media was founded in 1998 as a 3-D
digital-art development and offshore outsourcing agency
for the flourishing PC game and edutainment industry
in the U.S. At that time, no other agencies were doing
this work in Vietnam, and the concept of outsourcing art
production overseas was still alien to Silicon Valley’s game
developers. It was very much a niche industry for which
students graduating from Vietnamese universities had no
training.
To make their vision a reality, the founders of Glass Egg
decided to hire the top 20 students from the best art
universities in Vietnam. The company’s chief technical
officer leveraged the training resources available online
along with his own expertise in the field to design an inhouse 3-D training program. The game-development
houses in the U.S. saw an enormous cost-cutting
opportunity, and as the company gained more clientele,
7
it invested more resources into employee training and a
formal program tied to an incentives-and-reward system.
What distinguishes Glass Egg is that it has worked to
bridge the gap at its very source: academic institutions.
Through partnerships established with local polytechnic
institutes, students can take courses in 3-D animation
and digital art design as part of the university curriculum.
These students may have the opportunity to work at Glass
Egg, depending on their performance in the program. In
addition, top performers within the company are eligible
for sponsorships to pursue higher education in Vietnam
and abroad.
It is clear that companies can take
control of their own destinies by
training and developing the skilled
labor force they require.
ISA TanTec is a major leather manufacturer, supplying
internationally recognized brands and employing more
than 1,000 people at its factory in Ho Chi Minh City.
Committed to producing a high-quality product in
customized colors and textures, the company places a
great deal of emphasis on employee training to achieve its
mission. Its senior leather technicians hail from Brazil and
Germany and are specialized in the manufacturing process.
The company has developed a comprehensively structured
curriculum to train its workforce, and the training process
can last up to three years for selected employees. They
receive a certificate of completion that is recognized across
the tanning industry. With their enhanced skills, they can
seek faster growth and promotions at TanTec or explore
opportunities outside the company.
Through formalized training systems, both Glass Egg and
TanTec have empowered their employees to acquire skills
that enable them to perform better and grow in their
respective companies and also leverage those skills to
further their long-term career prospects.
8
Closing the Education Gap in Kenya
Samasource is an international digital outsourcing provider
in Kenya that performs labor-intensive work such as image
tagging for self-driving-vehicle algorithms. With customers
such as Google, Facebook, eBay and Tesla, it is, in its own
words, “a leader in global sourcing for data projects that
require a human touch.” As one of three subsidiaries under
the umbrella of the nonprofit Sama Group, it focuses on
providing high-tech professional services at a profit while
also having a positive impact on society.
Samasource’s economic and social impacts revolve around
two axes. First, it employs low-income individuals from
vulnerable areas of Haiti, Ghana, Uganda, Kenya and India.
This practice has helped alleviate poverty and increase
local wage income by 114%. The cascade effect of this
footprint has led to better housing, improved health and
first-time access to primary education for employees and
their families.
Through its education branch, Samaschool, Samasource
is becoming an education engine for multiple highpoverty communities in Kenya. Rather than wait for the
local education system to provide sufficient workers
with relevant skills, Samaschool addresses this shortage
directly. It provides people in these high-poverty areas
with skills that help them become competitive in the digital
outsourcing market, including at Samasource. It does so
through a hands-on, market-driven curriculum that is
updated continuously to meet market needs.
Samaschool offers education opportunities not generally
accessible to low-income communities, enhances social
inclusion and is a source of highly qualified professionals for
Sama Group’s subsidiaries.
Samaschool’s value proposition encompasses three areas:
(1) Training is highly practical, craft-oriented and takes
place in groups, which boosts knowledge and feedbacksharing, and helps students develop teamwork skills.
(2) The academic focus is aligned with skills demanded
by Sama Group’s customers, which ensures students’
competitiveness at graduation and readiness to enter the
job market. (3) Samaschool offers alumni networking and
helps students in their job search.
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The Simba Corporation is a conglomerate spearheaded
by CEO Adil Popat. His daughter, Alyana Popat, leads the
Simba Foundation, which has the primary goal of setting
up a technical school. The school’s mission is “to provide a
platform for young people to create value that builds and
sustains their own future,” she said. “The main point that
needs to be elaborated on is the fact that students who
graduate from universities in Kenya tend to have little or no
work experience, therefore making it difficult for them to
join the job market.”
Her words underscore the increasing trend by large
companies worldwide to provide educational opportunities
that fill the gap between the skills taught at academic
institutions and those needed by job markets. They
share a strong social component by focusing on the most
vulnerable collectives of society and empowering and
developing reservoirs of underutilized human capital.
Fly program, Toyota through its Academy, and Safaricom
through its M-Pesa Foundation Academy are also investing
in a new paradigm for education in Kenya, one in which
companies are engines of social good and producers of
highly qualified professionals.
It is clear that companies can take control of their own
destinies by training and developing the skilled labor force
they require. Numerous companies around the world
are successfully and profitably able to enhance or even
supplant the formal education available for local workers.
As this model gains a longer track record and greater
visibility, it will become an increasingly critical driver of
success in the modern economy.
This article was written by Miguel González, Jackson Hui,
Andrei Margarit and Pushpak Pujari, members of the Global
Program within the Lauder Class of 2017.
Samasource and the Simba Corporation are not outliers
in this endeavor. Equity Bank Group through its Wings to
Growth Strategies in a Global Economy
9
Colombia’s Fashion Industry Moves Forward
Forget Paris and New York. Some of the hottest haute couture in the world is coming out of
Colombia, which is quickly building a reputation as the new home for high fashion.
Colombia has changed enormously in recent years. No
longer known for its high crime rate, it has now become a
popular holiday destination with a vibrant economy. One
sector that has evolved very quickly is the fashion industry.
How has Colombia emerged as a fashion center in Latin
America, rivaling the much larger markets of Brazil and
Mexico? Why have international brands as well as new
entrepreneurs been flocking to the country as they did to
Brazil several years ago?
From 2009 to 2014, Colombia experienced a 5.5% growth
in sales volume for clothing and footwear. This figure is
larger than those for Mexico (4.9%), Brazil (3.3%) and
Argentina (3.4%), according to research by Euromonitor
published in April 2015. The agency projects that future
growth in the Colombian clothing and footwear market
from 2014 to 2019 will be even greater.
One of the most important factors
that explains Colombia’s emergence
in the fashion industry is the
prominent textiles industry in
Medellin.
One of the most important factors that explains Colombia’s
emergence in the fashion industry is the prominent
textiles industry in Medellin. This industry generates 30%
of employment in the city, with about 50% of the exports
reaching the United States, Costa Rica, Venezuela, Europe
and Ecuador. As a result of the high quality of the fabrics
and the low cost of production, Medellin has long been
seen as an attractive manufacturing location for global
designers.
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The Colombian economy has improved in recent years as
a result of political and economic reforms initiated by the
governments of Álvaro Uribe and Juan Manuel Santos.
Uribe’s 2002-2010 presidency brought about a significant
reduction in crime levels due to the “agenda-of-domesticsecurity” initiative. Santos, president since 2010, has
continued this initiative through peace negotiations with
the guerrilla organization FARC.
Additional reforms have opened the Colombian economy
to global trade and entrepreneurship. Compared with
other countries in Latin America, the legal prerequisites
for establishing a business in Colombia are less demanding:
For example, no upfront investment is required to begin
a startup there. Furthermore, it is a favorable market
for international investment. According to the Heritage
Foundation’s 2015 Index of Economic Freedom, the
average tariff rate in Colombia is 4.4%, lower than that for
Brazil (about 8%) and Argentina (about 6%). Colombia is
also a member of the Pacific Alliance, which encourages
cross-border investments between Chile, Costa Rica,
Mexico and Peru. Foreign and domestic investors are
generally treated equally under the law, and credit is
allocated on market terms, with foreign firms receiving
equal treatment.
As a result, Colombia was named in 2015 as the best
country in Latin America to do business by the World
Bank and an international leader in entrepreneurship by
the World Economic Forum. It has experienced growth
of 5% in its economy, with unemployment falling to its
lowest level in more than a decade. A 2014 report from The
Business of Fashion, an online publication that covers the
industry, mentions that Colombia’s stability and security
improvements have contributed to an increase in purchases
by the public. Many Colombians who chose to spend on
luxury items abroad now feel safe enough to spend their
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
money locally. Likewise, there has been an increase in the
number of middle- and upper-class Colombians choosing
to remain in Colombia rather than move abroad. The
confluence of all these factors has led to an influx of local
and international brands, including Spain-based clothing
and accessories retailer Zara, entering the Colombian
market.
“I believe Colombia really opened up as a ‘serious’ fashion
market with the arrival of Zara,” said Natalia Uribe, Fashion
Editor of Esquire Colombia. “The good results this venture
brought Inditex led to other brands wanting to invest in
Colombia. It’s been seven years since, and now other major
middle market and luxury brands are coming in.”
The Arrival of Luxury Brands
In 2012, Ferragamo, Longchamp, Montblanc, Vilebriquin
and other brands set up shop in the capital city of Bogotá.
Burberry, Dolce and Gabbana, and Tiffany & Co., among
others, followed the next year. According to Kelly Talamas,
editor-in-chief of Vogue Mexico and Latin America,
“Roughly around 2009 or 2010, there was a change of mind
regarding Colombia in general — a more hopeful outlook
on its potential. Around this time, the country became safer
and there was this Wild West effect because, aside from a
few pioneers like Louis Vuitton, MaxMara and Hugo Boss,
it was an unexploited market both for investors and for
international brands.”
The entrance of international brands has helped to spur
the domestic fashion industry, turning Colombia into one of
the most prominent and relevant destinations for industry
professionals in all of Latin America. As described by
Brenda Diaz de la Vega, editor-in-chief of Harper’s Bazaar
Mexico and Latin America, “To a certain extent, it was an
advantage because the local fashion industry was able to
develop during these years. I think that if international
brands would have arrived in Colombia 10 years ago, the
local talent would not have had the chance to show their
work.” Inexmoda, a private Colombian institute for fashion
and exports, annually hosts two of the most relevant events
for fashion and textiles in Medellin: Colombiamoda and
Colombiatex.
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Colombiamoda, Colombia’s version of New York’s Fashion
Week, takes place in July. In 2015 the event attracted
over 60,000 visitors, including 13,000 buyers (about 20%
international) and generated over COL$1,063 billion
(US$340 million) in deals, an increase of 11% over the
previous year. Colombiatex is a world-class textile fair,
promoting local factories and production that currently
represents 12% of the country’s GDP. According to Carlos
Botero, president of Inexmoda, “It is the most important
textiles-based event in Latin America … a trade fair that
could represent US$150 million in terms of business
opportunities, making it a fair that has a true impact on
industries, on businessmen and those attending, and the
visiting buyers will find really interesting, innovative and
complete offers.”
Many Colombians who chose to
spend on luxury items abroad now
feel safe enough to spend their
money locally.
The 2015 event boasted over 500 exhibitors and attracted
over 10,000 buyers from all over the world. Both events
are key opportunities for local talent and businesses to
showcase their latest designs and innovations and have
strongly encouraged the rise of entrepreneurship.
The presence of organizations such as Colombiamoda
that work to promote local talent and propel the industry
forward is incredibly important because Colombian fashion
is representative of the country’s cultural diversity. It is
celebrated as a source of pride, demonstrating creativity
and artistry and promoting a positive international
perception. The Colombian people are extremely patriotic
and display a contagious passion for their singers, athletes
and even designers, who receive support from within the
country. It is impressive that, in light of the arrival of more
recognized international brands, the majority of sales there
come from local products. Designers such as Julieta Suarez
affirm that Colombians prefer fashions that are loyal to
11
their local identity. She notes that “the arrival of luxury
brands resulted in Colombians appreciating and supporting
their national designers more, increasing [their] visibility, in
[their] being more exclusive and [of] higher quality.”
The entrance of international brands
has helped to spur the domestic
fashion industry, turning Colombia
into one of the most prominent and
relevant destinations for industry
professionals in all of Latin America.
The growing attention Colombia has been receiving from
the global fashion community can also be attributed to a
big push from Latin designers already living abroad, which
started piquing an interest in the region, according to
Talamas. Colombian fashion is anchored in national pride,
which can be seen in sales and in the backing it receives
from various entities. This support system is demonstrated
by Creo Consulting, a platform created by two Colombian
cousins, Giovanna Campagna and Claudia (Cloclo)
Echavarría, to promote Latin American fashion and design.
The pair strive to “create a program like the CFDA in the
USA, an incubator program for young talent in Colombia.”
They embody the entrepreneurial spirit just as much as
the designers they represent do, launching campaigns
and trying to generate opportunities for the Colombian
industry to grow to the level at which it can be competitive
with the fashion sectors of Paris, Milan, and the U.S.
Staying Loyal to Their Roots
With regard to Colombia and its national identity, a strong
connection exists between the country’s natural resources
and its fashion. Its designers are loyal to their roots: Their
collections are influenced by their communities and
traditions, which can be seen in the fluid silhouettes, highquality craftsmanship and raw-material selection. The
integration of these elements shows not only the beauty of
the country, but also the positive social impact behind the
process.
12
For example, the luxury handbag brand Mola Sasa depends
on the molas (woven patterned fabrics) made by the
Kuna women from an indigenous community in the Alto
Caimas province of Urabá. Designer Yasmin Sabet creates
the exterior of the bags using the molas and the interior
from a local natural fiber. She said it is important to her
to include the word mola in the brand name because she
wants to recognize and share the very personal artistry
that is produced by this community of women. Every
piece is unique and tells a story of the woman who wove
it. It follows then that each bag is representative of the
Colombian identity, but even more so of the indigenous and
less-familiar regions of Colombia.
The growing recognition of Colombia’s fashion industry
also calls attention to the obstacles in the sector and the
areas that still need to be developed. Some production
issues in Colombia don’t exist in other countries that have
been involved in fashion for years and have established
processes in place. Campagna and Echavarria identify
the difficulty of integrating a standardized sizing system
for shoes and the lack of good quality control as major
issues, while Paula Herrera, creator of the handbag brand
MAPA Collective, notes the communication issues and
a lack of urgency in Colombian production. In addition,
there is currently a lack of diversity in university programs
dedicated to fashion. Campagna and Echavarria insist that
there must be a change of mindset in Colombia for fashion
to be accepted as a “form of art” so it can be featured in
museum exhibits and appreciated beyond the runways and
boutiques. There are several areas for improvement, and
not just in the fashion world. Colombia is a country that,
until recently, did not require formal structuring in various
sectors. Accelerated development in the last few years has
brought about a conversation on how to modernize and
adapt with this growth. The vision at Creo Consulting and
other platforms could help to transform the fashion and
design sphere in Colombia, providing the resources and
support to keep it flourishing.
In conclusion, Colombia’s healthy economic rise has opened
doors and attracted many international fashion brands
in the last few years. In turn, their success has enabled
the fashion industry to blossom domestically. Through
various efforts by Inexmoda, namely Colombiamoda and
Colombiatex, Colombia has been able to establish itself as
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
an important fashion hub in the region and continues to
gain international attention. The industry has thus invested
heavily in supporting the development of local talent,
creating a marketplace for design that is strong in national
culture and identity. As Colombian designers like Silvia
Tcherassi attain international appreciation and recognition,
international buyers will seek out Colombian design more
Growth Strategies in a Global Economy
and more. Colombia is truly an emerging market with many
opportunities for growth and development as it continues
to evolve in the coming years.
This article was written by Christina Cerezo, Vanessa Frances
and Jessica Kong, members of the Lauder class of 2017.
13
Rio 2016: Winning the Olympics Bid
Securing a bid to host the Olympics is a big win for any city. But before the games begin, millions
must be spent on facilities, transportation, security and environmental mitigation. For cities such
as Rio de Janiero, which will host the 2016 Summer Games, it is an opportunity to create a legacy
beyond the closing ceremony.
Hosting the Olympic Games can be a transformative
experience that encapsulates the beauty, history and emotion
of a city or country. The drama and glamour of the opening
ceremony alone are a highly anticipated moment of national
pride for the host nation. One landmark moment in American
sports, for instance, is the image of Muhammad Ali lighting
the Olympic torch in Atlanta, Georgia, in 1996.
At the same time, hosting is undeniably an arduous process to
manage, which is why the International Olympic Committee
(IOC) places great emphasis on its selection process. In
several instances, the host faced challenges that came with
potentially damaging long-term results. For example, the
2004 Summer Olympics in Athens cost twice as much as the
projected budget, and the lasting image of decaying stadiums
has left Greece with enormous costs, both financially and
politically.
The Olympics always entails
investments in facilities that are
developed exclusively for the event but
are difficult to integrate into the city’s
lifestyle after the closing ceremony
sets off its final fireworks.
In October 2009, the IOC chose Rio de Janeiro to host the
2016 Olympic Games. The other shortlist candidates were
Chicago, Madrid and Tokyo. As possibly the first South
American host, Rio developed its bid around a “Live Your
Passion” theme that left a strong impression on several IOC
officials. Nawal El Moutawakel, president of the 2016 IOC
Evaluation Commission, was impressed by her visit to Rio,
stating, “We found behind then-Brazilian President Luíz
Inácio da Silva a dream of a city and also a dream of a nation.”
14
In examining the key details of Rio’s bid, the commission’s
report recognized that the city had benefited in both
structure and personnel from successfully hosting the 2007
Pan-American Games. In addition, the $240 billion (R$480
billion) needed to finance the project was fully guaranteed
by a mix of public and private players, and the bid had “the
full support of the three levels of government (federal, state
and city) across all political parties, as well as that of the
private sector.” According to the report, 85% of Rio’s public
supported the bid, along with 69% of the Brazilian public.
Since winning the hosting rights, Rio 2016 has been
challenged by its relationship with both national and
local governments in managing the project. Throughout
the bidding process, Rio 2016 president Carlos Nuzman
presented alongside members of the Brazilian government.
Perhaps most notably, the final pitch to the IOC was
conducted by Henrique Meirelles, the former president of the
Bank of Brazil. In preparation for the Olympics themselves,
the government and Rio 2016 are operating as two separate
entities. In its most recent Annual Sustainability Report
(September 2014), the IOC separates the project’s tasks into
three groups: “areas where Rio 2016 has/will have direct
control,” “areas where Rio 2016 has/will have influence,” and
“areas that are beyond Rio 2016 control/influence.”
The final category is described as being the responsibility
of the local, state and federal governments. Tasks in that
category include construction of the committee’s offices
and carbon-footprint reduction, both of which are the
responsibility of the state and local governments. In July
2015, Sidney Levy, CEO of Rio 2016, confirmed this division
of assignments: “Rio 2016 develops the technical plans but
their execution is the government’s responsibility.”
One of the most innovative public-private partnerships for
Rio 2016 is an agreement between the IOC and Airbnb to
increase guestroom availability throughout the city. Airbnb,
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the world’s largest web-based hotelier, will leverage its
network of some 20,000 private rooms in Rio to host guests
from all over the world. This will be the first time that a
business based on the shared economy model has been
selected as a sustainable and viable alternative to a large
hotel investment for an international sporting event.
The agreement also represents a significant wage-earning
opportunity for the city’s inhabitants. Revenues are expected
to surpass the $26 million spent on private-apartment rentals
during the 2014 World Cup, which Brazil also hosted.
Other ambitious projects that were approved by Rio’s
political leaders fell into disarray once a financial crisis hit
Brazil. One example is Morar Carioca, a “revolutionary
project in social integration, unique in all of Brazil,” as Mariana
Cavalcanti, one of the authors of the project, described it.
Launched in 2010, this initiative was designed to urbanize
all the favelas in Rio by 2020. In addition to creating street
layouts and building recreational areas, it would have brought
significant improvements in education, health and other basic
services. But the project gradually disappeared from the
agenda because of budget constraints.
At the same time, other public-private partnerships have
not been as successful. For example, Uber’s participation
in the games has met resistance from different groups in
Brazil. Once considered a potential partner to provide
transportation alternatives in Rio, the platform was not
selected after multiple protests by the cab drivers’ union and
unfavorable regulations passed in other states, including São
Paulo and Brasilia.
Rio 2016 merely helps to develop a
social conscience that could foster Rio’s
profound transformation into a more
cohesive and secure city in the future.
In addition, the Olympic golf-course project in Barra da Tijuca
has been plagued by protests. To comply with requirements
set by the International Golf Federation, the course was
built on the Marapendi reserve, which has negatively
affected the biodiversity in one of Rio’s few natural reserves.
Concurrently, there are suspicions of corruption because the
government has authorized construction of 22 apartment
buildings with more than 20 stories each within the
reserve. These buildings violate existing environmental and
construction regulations, and the cost for each apartment is
estimated between R$6 million and R$13 million ($2 million $4 million).
The Olympics has had an indirect impact on the social
transformation that Rio has witnessed since 2009.
However, the direct impact of Rio 2016 in the city’s social
transformation will be temporary and limited — mainly
through the creation of 80,000 jobs during the celebration
of the games. According to Levy, “the games don’t have the
capacity to alter some of the perverse social structures that
Brazil has had for many years.” Thus, Rio 2016 merely helps to
develop a social conscience that could foster Rio’s profound
transformation into a more cohesive and secure city in the
future.
For the IOC, a major aspect of Rio’s winning bid was the
importance of socioeconomic development. Undoubtedly,
hosting the Olympics has revitalized the efforts of city
leaders to improve the precarious conditions for those living
in Rio’s favelas or slums. The focus in the last few years has
been on urbanization through the construction of cable cars
and other forms of public transportation, and security with
the placement of Pacifying Police Units (UPPs) inside the
favelas. Since 2009, many favelas have witnessed significant
improvements and have even become tourist destinations.
The installation of UPPs in nearly 40 favelas has led to a
reduction in violence across the city.
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Room for Improvement
Two primary areas that have emerged in terms of relevant
infrastructure for Rio 2016 are transportation and
game-specific facilities. Improvements in transportation
infrastructure could be a legacy for Rio, a city that has
received astonishingly little investment in this sector. At the
same time, the development of Olympics-specific facilities
is tied more directly to the host city’s execution capabilities.
As past experiences have demonstrated, the constructed
facilities are rarely maintained and typically fall into disrepair
a few years after the conclusion of the games.
15
Rio has had a long-standing history of underinvestment in
transportation infrastructure. This has resulted in a series of
problems, including the failure to integrate different areas
of the city, poor maintenance of existing transportation,
overcrowding and occasional breakdowns. With these
deficiencies in mind, Rio 2016 included the following projects
as part of its candidacy proposal:
1. Implementation of a light rail system (VLT)
2. Development of an alternative bus rapid transit (BRT) that
will operate on exclusive tracks
3. Extension of the existing highway system (elevador do joá
and viario da barra)
4. Construction of Line 4 on the subway system
The overall goal was to provide efficient publictransportation alternatives that could easily connect all four
regions involved in the Olympics (Maracaná, Copacabana,
Barra, and Deodoro). By October 2009, these projects
were either already underway or had been analyzed by
Rio’s government. Even though the IOC did not develop the
The true legacy of the Olympics will
be realized only if the authorities and
inhabitants in Rio de Janiero succeed
in maintaining these programs beyond
2016.
initiatives, it served to promote and facilitate these projects.
The first three projects were implemented on time and have
met all their intermediate milestones. They are expected to
be operational by the time the Olympics begin. However,
construction of Line 4 on the subway system is behind
schedule, and private analysts are skeptical that it will be
completed in time.
With regard to infrastructure impact, the Olympics
always entails investments in facilities that are developed
exclusively for the event but are difficult to integrate into
the city’s lifestyle after the closing ceremony sets off its final
fireworks. Rio’s people and government are well aware of
this. For example, as soon as the 2007 Pan-American Games
16
ended, the Maria Lenk Aquatic Park fell into disuse. These
developments often result in negative impacts for the host
community in the medium to long term, thus making Rio
2016’s hopes for a long-lasting legacy dubious.
Nevertheless, Rio 2016 decided to maximize the functionality
of certain facilities by means of “nomadic architecture.”
This practice focuses on transforming what may have been
a single-purpose venue into a multifunctional facility. For
example, Olympic Hall 4, a full-fledged handball and goalball
stadium, is being built in the Barra region. After the Olympics
end, it will be dismantled and reassembled into four municipal
schools that will host 2,000 students. Even though these
developments entail a higher investment for conventional
sports facilities (25%-30% more for this particular project),
the positive social impact outweighs the increased spending
from a city-planning perspective.
Environmental Footprint
In preparing for the Olympics, a frequent area of focus
revolves around the event’s environmental impact. As the
Rio 2016 Committee noted, “imagine the impact of this on
the consumption of natural resources, like water and energy,
on the consumption of food and raw materials, and on waste
production.” Environmental practices represent one of the
main challenges for the Olympics but are also a unique
opportunity to disseminate a culture of sustainability in Rio.
According to Levy, “Rio 2016 has a commitment to work with
public and private entities to minimize waste and carbon
emissions because of the games.” He acknowledged these
objectives will be a huge undertaking. Current estimates
by the committee show that the games will result in the
production of 17,000 tons of waste and the consumption of
23.5 million liters of fuel and 29.5 gigawatts of electricity.
Managing this environmental footprint will require a
comprehensive strategy. The Rio 2016 Committee, in
collaboration with its public and private partners, has
developed a number of studies and programs to address
waste management. However, public participation will be
essential to ensure success. The authorities are trying to
educate Rio’s citizens and alter their behaviors. One of the
most innovative solutions presented to date involves using
recycling cooperatives, located in the favelas, to manage
waste and to provide additional income opportunities to
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the residents of those communities. Multiple investments
to encourage the use of ethanol for transportation and
electricity-generation purposes will help reduce carbondioxide emissions.
Water management requires a very different approach. Rio
2016, along with the Brazilian authorities, has pledged to host
sports-based competitions in natural bodies of water during
the games. However, many athletes and private organizations
are not satisfied with the results of the cleansing projects
in these settings, particularly in the Bahia de Guanabara.
Levy recognizes that not all the cleansing projects will be
completed in time. Local authorities and the committee are
erecting temporary garbage-containment barriers in bodies
of water to improve sanitation conditions. These measures
have proven to be effective on a temporary basis, but the
underlying pollution in Rio’s main bodies of water will remain
an issue beyond 2016. This topic is critical, particularly
now that Brazil is in the middle of a water crisis due to poor
infrastructure and the growth of water-intensive industries.
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The transformative power of the Olympic Games for Rio is
undeniable. This is particularly true in light of the massive
investments in transportation, reusable infrastructure
and public-private partnerships that will have significant
and tangible impacts on the city. Historically, the games
have served as a catalyst for implementing social and
environmental programs. However, these projects are just
a starting point in addressing a long list of issues in these
areas. The true legacy of the Olympics will be realized only
if the authorities and inhabitants in Rio de Janiero succeed
in maintaining these programs beyond 2016. Hosting
international sporting events such as the Olympics provides
the right setting to implement projects of large-scale societal
impact, but they are not a one-stop solution to long-standing
challenges for the host cities and nations.
This article was written by Michael Alerhand, Pierre Le Normand,
Guillermo Medina, Francisco Taboada, and Lorenzo Zavala,
members of the Lauder Class of 2017.
17
The Chinese Investor: Monolith or Mosaic?
Many stereotypes persist about China, not least on how the typical Chinese investor thinks.
This look at four investors offers a glimpse into real-world examples.
Little news garnered more attention in the financial
press last year than China’s stock-market meltdown in
late 2015. Professional investors, analysts and pundits
have attempted the herculean task of understanding the
Chinese investor, who is not some monolithic entity but
rather a rich mosaic of unique individuals, all with distinct
stories and backgrounds that have shaped their approach
to investing. One way to grasp the diversity of Chinese
investors is to examine several different cases.
Kevin Lee: The Conservative Professional
Kevin Lee is your typical mid-career professional. A
resident of Beijing, he is part of a two-income household,
has two children, owns his own apartment and drives
an imported SUV. He is well-educated, having earned
a master’s degree in education from Beijing Language
Culture University, and well-traveled. Both he and his wife
work in education. While their salaries may lag behind
those of other professionals, the benefits, including free
day care for their toddler, help to narrow the gap.
The “Chinese investor” is not a
monolith but rather a mosaic of
hundreds of millions of individual
investors, all with their own risk
tolerances, investment criteria
and means of interacting with the
market.
Lee’s approach to risk is representative of not only many
mid-career Mainland Chinese investors, but also many
private, middle-class investors in developed countries.
He views property markets, particularly in China’s firsttier cities such as Beijing and Shanghai, as significantly
more stable than the country’s stock markets. He feels
18
that demographics, the household registration system,
employment opportunities and access to medical and
educational services will continue to support prices in these
major cities. If home-price appreciation in Beijing continues
to slow, he will likely buy his first rental property.
In contrast, Lee’s confidence in China’s equity markets was
shaken during the meltdown. Fortunately, he did not own
any financial assets at that time, although he plans to enter
the market in the future. When asked to what he attributes
China’s current market weakness, he responds that stock
markets in China, as elsewhere, are simply inherently risky.
Even though he does not attribute the late-2015 rout to
meddling by foreign investors, as some Chinese media
outlets have insinuated, he does not propose a specific
alternative cause, such as anticipation about when the
American Federal Reserve may begin to normalize U.S.
interest rates or the relative lack of other investment
options available to private Chinese investors. In response
to a question about alternative investments, he notes that,
aside from property and stocks, his investing experience
is limited. He mentions commodities but admits he has no
intention of investing in them.
What is telling about Lee’s investing experience is that
it seems to support the view that, even though retail
investors account for approximately 80% of the trading
that takes place in China’s stock markets, their holdings as
a percentage of total household wealth are quite limited
(currently estimated at around 5%). If this is truly the case,
the market rout’s impact on the broader economy may turn
out to be quite limited. The real question may center on
where the country’s property prices are headed.
Yuanxiang Ma: The Risk-seeking MiddleClass Entrepreneur
Yuanxiang Ma owned a small jewelry business in
Zhengzhou, Henan Province. His wife works as a bank
teller. Their daughter just turned 13. Ma is in his mid-40s
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and never attended college. After high school, he started
working for a small business that produced store signs.
At the same time, his older sister established a successful
jewelry business. After several years, Ma joined her
operation and eventually took over and became its sole
owner. During its most profitable periods, he was earning
more than ¥650,000 (over US$100,000) annually from
his jewelry counters in department stores. However, the
growing popularity of e-commerce in China gradually
eroded his profits, forcing him to close his business. Looking
for a new source of income, he began dabbling in the stock
market.
It is important to note that Ma represents a generation that
did not have ready access to a college education. Prior to
1999, university graduates accounted for less than 5% of
the total population, according to figures from the World
Bank. Following educational reforms in the late 1990s,
the ranks of China’s college-educated populace swelled,
creating a clear dichotomy between those with and without
a degree. Facing intense competition from a younger, more
educated generation, Ma and many members of his age
group had little choice but to establish their own companies
or work in blue-collar occupations. The lack of a financial
education and pressure to make a living sometimes pushed
members of this cohort to engage in higher risk-taking
behavior, as Ma’s experience demonstrates.
For several years, Ma has been investing in stock-option
indices categorized among the riskiest financial products
on the market. His motivation is simple: “People who bet
options are dreaming big. I want to win big.” He believes
that any of the alternative investment selections available
in China offer yields that are simply too low. Furthermore,
real-estate prices have risen too rapidly in recent years, and
Ma feels it is already too late to enter this market.
Even in an environment in which many financial products
offer yields in excess of 6%, he wants more. He admits he
is out of his element, as he does not have the expertise
to participate in such a risky market. Yet he is still willing
to invest half of his savings in China’s options market. He
invests through a friend, who has been betting on options
for years and convinced Ma that losses to his investment
principal were unlikely. Unfortunately, his friend lost a
significant amount of his own principal during the 2015
Growth Strategies in a Global Economy
meltdown (approximately ¥108 million). Ma says, “I still
have faith in the market.” Once it stabilizes, he hopes to
invest more in China’s options market to recoup his losses.
Ziqiao Ji: The Perspective of a Young
Master’s Student
Ziqiao Ji is pursuing a master’s degree in the foreign
language department at Beijing Foreign Studies
University. The Chinese high-school placement exam,
known as gaokao, placed her into computer science as an
undergraduate, so her background is more quantitative
than that of her peers. Aside from the financial burden of
tuition and a lack of income as a student, Ji is relatively
The real question may center on
where China’s property prices are
headed.
unencumbered financially. In her spare time, she enjoys
dance and makes some money on the side by teaching salsa
classes to younger children.
China’s financial technology has made the local stock
market more accessible and investible than ever, especially
to mobile- and tech-savvy investors. With some of her
side income, Ji has joined the throngs of younger investors
engaging in chao gupiao, or speculative stock investing.
One notable mobile app in this space that Ji uses frequently
is Tonghuashun, which translates as “straight flush,” a term
borrowed from poker. This app provides an impressive host
of free services and functions, including technical indicators
such as various moving averages, motif-based investing
indices such as the popular “military industry” and “Jack
Ma’s ideas,” and forums for discussion about various stock
issues.
Behind a paywall lie more advanced features and valuation
metrics. Despite a name with gambling connotations, the
app is widely popular and facilitates broader access to the
Chinese stock market. Armed with a few early wins, Ji notes
that she feels comfortable continuing to invest in the equity
market with the gains from her initial investments, because
doing so would preclude her from sustaining any net losses.
19
Ji has diversified with the initial funds, using money-market
investment products provided by large Chinese mobile and
e-commerce companies Alibaba and Tencent. These online
investment vehicles have been on the market since June
2013 and January 2014, respectively, and offer rates often
greater than 6-7% in products reminiscent of peer-to-peer
lending.
Ji views these investments as safe, given the two
companies’ solid reputations. She feels they are a good way
to reduce risk by being invested solely in the equity market.
She also attests to the relative ease of the two products.
Because the companies already have access to customers’
regular Chinese bank accounts (through Zhifubao
and Weixin, their respective mobile and e-commerce
platforms), choosing to invest in one of their higher-paying,
money-markets products is virtually seamless.
“People who bet options are
dreaming big. I want to win big.”
Mr. Wei: A Sophisticated Individual
Investor in China’s Tumultuous Market
Lanzhou is the most unlikely place to start an investing
career. Straddling the upper reaches of the Yellow River,
it is closer to the inhospitable Gobi Desert than to the
economic miracles of coastal China. Born and raised in
this city, Mr. Wei (who did not want to be identified by his
full name) first encountered the stock market when his
mother’s company privatized in 2001, just after China
joined the World Trade Organization and thousands of
state-owned companies underwent privatization.
Wei’s mother bought about ¥30,000 in company stock
options prior to its initial public offering. Within a few
days of listing, the company’s stock price had risen from
¥1.00 per share to over ¥5.00 per share. Having made
more than ¥300,000 in profit, Wei’s mother sold her
options after her lock-up period ended. However, her next
investment was not as fortuitous. With no prior investing
experience and without researching her investment targets
beforehand, she invested all of her previous profits into
20
a single company. When a bear market hit a few months
later, the share price plummeted and took a number of
years to recover. When the share price finally recouped its
losses in 2006, Wei’s mother sold her holdings and turned
management of the assets over to her son.
Unlike his mother, Wei was still young, brash and willing to
gamble. He invested the entire sum in a battery company.
The company’s strong performance, along with a growing
bull market, more than tripled the share price. As his asset
base grew, Wei also spent more time learning how to invest.
He quickly realized that his previous investments were
incredibly risky, given the level of concentration. While
running his own media and advertising firm during the day,
he began to formulate a more sophisticated investment
strategy. In his next round of investments, he allocated only
a portion of his asset base.
In 2007, Wei had made enough money to pay off the
mortgage on his new home. By then he had gained a
stronger grasp on valuation methodologies and knew his
holdings were too expensive. He effectively reallocated his
assets from the equities market to real estate. Again, his
timing was fortuitous, occurring just as China was entering
a multiyear real-estate boom.
After paying off his mortgage, Wei allocated his remaining
assets to two emerging trends. He invested some money
with companies that his friends had started. He also
placed some of his cash in loan companies that provided
financing to small and medium enterprises (SMEs). These
latter investments were riskier than bank deposits but
compensated with a higher interest rate. Given the state of
the bond market in China, Wei had very little choice in the
fixed-income market outside of bank deposits.
Dreaming Big
One theme unites all of the aforementioned investors: They
continue to believe in China’s growth potential.
While unanticipated, the 2015 meltdown can be explained
in part by the investors’ collective experiences over the last
few decades, when China was growing at a dizzying pace.
This experience also influenced their approach to investing.
Like Ma, almost everyone wants to win big. The challenge
currently confronting China is not only one of transforming
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
the economy, but also tempering people’s expectations.
The years of double-digit growth in the country’s gross
domestic product have likely passed.
The “new normal” will entail slower but potentially
more sustainable growth. However, human emotions
and psychology often lag behind reality. China’s current
market turmoil can be attributed to some degree to this
disconnect. Fortunately, the ranks of China’s irrationally
exuberant (think Ma) are offset at least partially by those
with cooler heads (think Lee). What is clear is that the
“Chinese investor” is not a monolith but rather a mosaic of
hundreds of millions of individual investors, all with their
own risk tolerances, investment criteria and means of
interacting with the market.
China’s financial technology has
made the local stock market more
accessible and investible than ever,
especially to mobile- and tech-savvy
investors.
This article was written by Charles McCarren, Travis Pfander,
Sumiko Taku, and Ray Wang, members of the Lauder Class of
2017.
Growth Strategies in a Global Economy
21
Getting to Scale: Colombian Startups Look to
International Growth
The business environment is changing in Colombia, and the country’s economy is transforming
along with it. Yet it’s still a struggle for startup ventures that are trying to get off the ground.
Nestled on a tree-lined street in the Chapinero — Bogota’s
central business district— the headquarters of Polymath
Ventures occupies an English-style home once used as
the campaign office of Colombia’s current president, Juan
Manuel Santos. Polymath’s headquarters is symbolic of
Colombia’s entire entrepreneurial ecosystem: It incubates
new enterprises to occupy Colombia’s increasingly vibrant
economy.
Indeed, the past five years of Santos’ presidency have seen
a flurry of reforms, plans and public-sector initiatives to
promote entrepreneurship in Colombia. At Polymath,
financial advisers from startup Aflore convene down the
hall from an angel investor meeting. Upstairs, bay windows
and dark hardwood floors contrast with the office layout of
a modern startup. A new economy is emerging from the old.
Even though Colombia has made
tremendous strides, no venturebacked companies there today fit the
profile of the extraordinary North
American startup.
Understanding the state of entrepreneurship in Colombia
requires both an appreciation of the country’s rapid
progress and a sober understanding of the limits of that
progress. On one hand, Colombia has enjoyed years
of strong growth and macroeconomic stability. Gross
national income per capita has more than tripled since
2000, and the country continues to climb the World Bank’s
“Doing Business” rankings. An emphasis on public-private
partnerships has allowed Colombia to grow infrastructure
spending to 3% of the gross domestic product, compared
with 1.5% just 10 years ago. Well-supported public-sector
22
programs such as iNNpulsa Colombia provide education
and investment in the country’s new enterprises. A 2015
study by the Global Entrepreneurship Monitor (GEM)
and the World Economic Forum (WEF) praised Colombia
as one of a small group of “entrepreneurial all-rounders”
— countries that produce a large volume of innovative
startups that employ a significant number of people.
On the other hand, it is still too early to characterize
Colombia as a mature entrepreneurial economy. The
country’s entrepreneurs operate in an economy where
approximately 60% of nonagricultural employment
is informal. Women rarely participate in formalized
entrepreneurship. Even though the World Bank attributes
a 30% reduction in extreme poverty in Latin America to
women entering the workplace (with the highest rate
of entry occurring in Colombia), it is especially difficult
for women to make the transition out of the informal
market — particularly in light of challenges such as formal
financing. Of the 40 Colombian entrepreneurs highlighted
by the global nonprofit Endeavor since 2007, only four are
women.
Furthermore, Colombia’s 20th-century violence has
contributed to a capital environment that remains
conservative. Business angels are rare and true venture
capital funds number in the low single digits. Investors
typically operate on a small scale with very short time
frames when dealing with entrepreneurs. In addition,
the new Colombian businesses that do succeed are
likely to bump up against the limited size of the domestic
market. Even though Colombia outpaces Latin America’s
GDP growth, its economy is still less than half the size of
Mexico’s and about a quarter as large as Brazil’s.
Chasing Extraordinary Growth
Perhaps the ultimate measure of a country’s
entrepreneurial economy is the extent to which new
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
enterprises have contributed to output and employment.
An often-cited statistic from the National Venture
Capital Association states that even though venturebacked companies make up only a small share of the total
number of new enterprises in the United States, they
account for about 20% of GDP and 10% of employment.
The disproportionate impact of highly successful new
enterprises is why governments the world over preach
entrepreneurship and take public-policy measures to
jumpstart the process.
Even though Colombia has made tremendous strides, no
venture-backed companies there today fit the profile of
the extraordinary North American startup. So what’s the
playbook for a new Colombian business that aspires to
global economic impact? Ash Kirvan, a partner at Polymath,
believes his company has a plan to address two of the most
difficult obstacles Colombian entrepreneurs face: a weak
entrepreneurial ecosystem and the limited size of the
country’s domestic market.
Entrepreneurial ecosystems include entrepreneurs
themselves, the incubators that help them develop their
business ideas and a venture capital community that
provides the seed investment needed to begin operations
and grow. As Kirvan notes, the venture ecosystem takes
time to emerge organically. He explains that building a
strong ecosystem usually necessitates work over at least
a generation as it requires the involvement of alreadysuccessful entrepreneurs to function at scale. The first
generation — as is the case in Colombia — needs to gain
the capital and experience before it can advise and fund
others. Likewise, it takes time to develop relationships
among investors, entrepreneurs and important supporting
institutions such as universities. The 1959 investment
in Fairchild Semiconductor, widely considered the first
venture capital investment in Silicon Valley, preceded a
strong Silicon Valley ecosystem by decades.
Polymath speeds up the process by combining the
elements of a venture ecosystem under one roof and
connecting them with an international pool of talent
and capital. It incubates its new business ideas through a
four-month international fellowship program called Seed.
Seed convenes professionals from inside and outside
Colombia to tackle a topic area such as financial services,
Growth Strategies in a Global Economy
transportation or working women. Its teams have global
connections and a variety of talent in engineering, design,
ethnography and business. The companies that emerge
from the program receive funding from one of Polymath’s
LABS funds, a set of startup capital funds supported by
international investors. As companies grow, Polymath helps
them secure additional capital from business angels and
other venture investors. The result to date has been five
new businesses, with plans to double that number in the
next two years.
Valuations will not match the
stratospheric levels of Silicon Valley,
but success in Colombia will be
cheaper and more frequent when
companies combine the right capital,
talent and knowledge.
Polymath addresses the second obstacle — the size of
Colombia’s domestic market — through the expansionoriented business models of the companies it develops.
All Polymath companies are designed to play off market
opportunities and trends that affect many countries in Latin
America. The region’s surging middle class is an underlying
trend. For example, rising per capita incomes have resulted
in dramatically increased car ownership in countries such
as Colombia and Peru. However, when car owners need
to service their vehicles, their options are usually limited
to informal repair shops or expensive dealership service
departments. Autolab, one of Polymath’s companies, aims
to be the third option, providing high-quality service at
an affordable price. As Kirvan explains, Polymath invests
in ideas that it believes could represent regional value
propositions worth US$1 billion or more.
Regional growth models are especially promising in Latin
America for a variety of reasons — some of them new and
some of them old. Cultural similarity and compatibility
across many Latin American countries facilitate newmarket entry. While it would be wrong to deny the
significant internal diversity of the region, simple factors
23
including a common language have been the basis for
successful international expansion across Latin America
since the 1980s. For example, Grupo Bimbo — the US$11
billion Mexican food giant — has built strong positions
across Latin American markets over the past three decades.
Today, the growth of multilateral bodies such as the Pacific
Alliance among Chile, Colombia, Mexico and Peru has
connected broad swaths of Latin America like never before.
As investment and people flow more freely across the
region, expansion plans will become more appealing.
Regional growth models are
especially promising in Latin America
for a variety of reasons — some of
them new and some of them old.
Beyond the Power Curve
While much of Colombia’s entrepreneurial project aims to
replicate the success of advanced ecosystems like Silicon
Valley, there is reason to believe that the former’s new
ventures will behave and grow differently than those in
North America given the fundamental difference in the risk
profile of investments in each place.
A key distinction lies in the concept of the “power curve”
that Peter Thiel used to characterize his experience as
24
an entrepreneur and investor in the U.S. North American
startups succeed infrequently. Thiel explains that his
venture capital company, Founders Fund, counts on its
investments succeeding extraordinarily only one time out
of 10. Furthermore, most of the value produced by these
extraordinary companies will not appear until years later.
The U.S. venture investor is often swinging for home runs.
In comparison, the risk profile of a Colombian venture is
entirely different. There are few venture capital funds to
compete over deals. Many target industries are full of weak,
fragmented and informal players that could not compete
against top talent, the right business model or sufficient
capital. Startups that do succeed are likely to generate
cash much faster than in the U.S. Valuations will not match
the stratospheric levels of Silicon Valley, but success
in Colombia will be cheaper and more frequent when
companies combine the right capital, talent and knowledge.
Today, many Colombians are returning home. Equipped
with both education and experience from abroad, they have
seen the economic improvement in their home country
and want to be part of it. Kirvan describes this movement
as a “reverse diaspora in historical scale.” As Colombia
continues to grow in talent, capital and connectedness
with the global economy, it should begin to realize the
extraordinary benefits of the venture economy.
This article was written by Renan Andrade, Koehler Briceño,
Randal Drew and Tom McElwee, members of the Lauder Class
of 2017.
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
The Flower Industry in Colombia: Current Trends
and Challenges
Colombia’s flower industry is a key export for the country, yet it faces many challenges. The
government and growers both have a role to play in making improvements.
Colombia is one of the most advanced economies in South
America, with a GDP growing at an annual average rate
of 4.6% over the last five years, according to the World
Bank. Its economy depends on two key industries: minerals,
including oil and gas, and agriculture, with coffee and
flowers among the most important economic products for
the country.
Colombia is the second-largest worldwide exporter of
flowers after the Netherlands. Its flower exports to the
United States have grown rapidly since the initial shipments
50 years ago. Today, the U.S. market is by far the dominant
market for its flowers, taking up 75% of the exports. Russia
is the second largest customer, but trails far behind at 5% of
the flower exports.
The Colombian flower trade is considered a model of
economic cooperation between Latin America and the
United States. Several early factors formed the basis for
this industry’s long-term viability and success. In August
1961, U.S. President John F. Kennedy launched the
Alliance for Progress, which aimed to increase economic
cooperation between Latin America and the U.S. with a
specific focus on agriculture.
In 1967, David Cheever, a graduate student in horticulture
at the University of Colorado, identified the industry’s
attractiveness in his master’s thesis, “Bogotá, Colombia
as a Cut-Flower Exporter for World Markets.” He noted
in his research that the region around Bogotá was ideal
for growing flowers, and its proximity to an international
airport and the U.S. made Colombia an ideal exporter. He
established a business in 1969 that become so successful
that nine competitors joined the export industry within five
years.
But the U.S. market has been a challenge as well, especially
due to consumers’ changing tastes. Take the case of Passion
Growers, one of the largest flower producers in Bogotá.
Growth Strategies in a Global Economy
It has been in business for 13 years and, through its welldeveloped network, delivers roses five to seven days after
they are cut. Moisés Croitoru, the company’s operations
director, said the three main sales markets for the
Colombian flower industry are the U.S., Russia and Japan.
Valentine’s Day, Mother’s Day and Christmas account
for over 50% of the annual demand in the U.S. market.
Planning to meet this capacity at specific times of the year
is challenging, especially in terms of hiring and training
temporary labor.
Colombia is the second-largest
worldwide exporter of flowers after
the Netherlands.
According to Croitoru, Colombian flower producers have
also had to adapt to the particular tastes of American
consumers, who do not want the larger flower heads
desired by Russian and Japanese consumers. As a result,
Colombian producers have developed shorter growing
cycles that facilitate mass and rapid production. In addition,
American consumers tend to fall under the influence of
trends in flower styles, so Colombian flower producers
must adjust their output frequently in terms of types and
colors. For example, Croitoru said that he changes his rose
plants every four to five years even though these plants
may produce flowers for up to 12 years.
Croitoru said Colombia’s flower industry has been looking
at ways to broaden its global opportunities. A number
of producers are exporting their flowers to new markets
such as Japan, despite the more expensive transportation
costs. This requires that the producers adjust their flower
cultivation and shipping processes to meet Japan’s strict
quality standards.
25
Expanding the Market
Japan is a premium market where flowers are sold at higher
prices than in the U.S, which makes these exports profitable
even with the additional transportation costs. Aiming at
selling into this market would reduce the dependence of
Colombian growers on exports to the U.S., and achieve a
more consistent revenue stream throughout the year.
As in the U.S., there is great demand in Japan for flowers
for special events such as Mother’s Day, Valentine’s Day
and Higan (spring and autumnal equinox days when
memorial services for ancestors are held). The Japanese
buy flowers more frequently for home decoration, floral art
or as congratulatory gifts. Moreover, Japanese consumers
are willing to pay a higher price for better quality. This
means that Colombian flower producers who meet the
requirements of the Japanese market can enjoy the
benefits of more stable demand and a higher profit margin.
Each percentage-point increase
in flower production reduces
the homicide rate. … In contrast,
coffee price hikes lead to a rise in
homicides.
At the same time, flower importers in Japan are thought to
be demanding, not only because of the consumers’ strict
requirements but also because of the specificity of their
orders. For example, when American importers order
flowers, they generally indicate only the color they want,
so the producers have more flexibility in selecting what
type of flower they supply. Japanese importers, however,
will order a specific variety of flower and will not accept
anything else, no matter how similar it may be.
In addition, flowers generally must be transported from
Colombia to Japan within 72 hours of being cut. Even
though the flower-production area is concentrated in a
suburb of Bogotá, about an hour from the principal airport
by truck, and the Colombian flower industry has improved
the shipping process significantly, it is still difficult to
complete delivery to Japan within 72 hours and control the
26
flowers’ bloom rate to ensure they will be in peak condition
when they are delivered.
New Government Policies Provide Some
Help
As noted above, flower exports are an important revenue
source for the Colombian economy. Yet the industry
is volatile and affected by many factors, including the
weather. Farmers also are one of the least protected
classes in the country. To understand recent trends in this
sector and the government’s role in it today, two aspects
must be considered. What has happened to the industry in
recent years? And how did the Colombian government’s
role evolve during this time?
It is important to understand the current situation from the
point of view of the local producers, especially those who
have spent many years in the sector. Croitoru noted that
the government has implemented two key tools to support
the sector: loans for farmers and an open-skies policy,
under which the cost of air transportation has decreased.
The flower industry, like most agricultural industries, is
unpredictable and requires investments in technology, land
and material. To purchase seeds and plants, companies
typically take out loans and repay them after the harvest.
There are two constraints on loans from private banks in
Colombia — the high interest rate and the banks’ reluctance
to issue loans to volatile and high-risk businesses.
To address this issue, the government in December 2014
established 40 different credit lines for agricultural
industries through Banco Agrario. This process gives
farmers access to credit in less than three days and takes
production cycles into account. Companies can apply for a
loan of up to $30 million for four years to invest in working
capital. The interest rate is set at 16.77% APR and fixed for
the life of the loan.
It is useful to compare the role of Colombia’s present
government with that of Holland, the largest flower
exporter in the world. The Dutch government had tried
to promote growth in the sector by subsidizing the cost of
new technology and allowing the use of new pesticides.
Currently, financing is processed by commercial agrarian
banks, such as Rabobank, which offer loans at a low interest
rate.
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
As for the Colombian government’s open-skies policy
introduced in 2011, the agreement with 36 countries
gives more airlines access to the Colombian market and
offers consumers more attractive prices. As a result,
transportation costs and delivery times have declined
significantly, and the competitiveness of Colombian flowers
abroad has increased.
Another important point to consider regarding the
Colombian flower industry is the workforce. This sector
employs primarily women who have little education.
It is difficult to underestimate the benefits for these
mostly rural employees who have few opportunities for
employment outside the home, especially in the formal
sector. In addition, 69% of the women employed are
heads of households. These women reap the benefits of
greater income, property attainment, an expanded social
network and increased self-esteem. Their jobs also change
the power dynamic in their households as they gain more
economic autonomy.
Increased female employment and empowerment create
ancillary benefits to society, especially around the flowerproducing areas. Murder rates have decreased in these
regions. According to a 2015 paper by Sara Hernandéz,
“Guns N’ Roses: The Impact of Female Employment
Opportunities on Violence in Colombia,” each percentagepoint increase in flower production reduces the homicide
rate in the flower-producing districts by 0.08 per hectare.
In contrast, coffee price hikes lead to a rise in homicides.
This phenomenon can be explained in part by the changing
household dynamics and reduced financial difficulties in
households with employed females.
Despite the benefits to society, workers in the flower
industry endure significant physical and emotional tolls.
Their jobs are solitary, repetitive and physically exhausting,
and employees work under hard deadlines. Often,
employees say the salary is the only positive aspect of the
job.
According to a paper by Corporación Cactus, a nonprofit
organization that works to improve the lives of those
in the flower industry, workers experience little job
Growth Strategies in a Global Economy
satisfaction, not much predictability, no sense of belonging
or emotional support, excessive psychological demands,
job insecurity and other challenges. Given that labor costs
for the industry comprise 55% of the operational costs (the
comparative figure for the textile industry is only 27%),
companies are reluctant to implement improvements that
increase costs or reduce productivity.
Workers in the flower industry
endure significant physical and
emotional tolls.
Nevertheless, the industry has made steady improvements
in working conditions, due largely to pressure from
importing countries. Florverde, a certificate of
environmental and labor standards, was created in 1996
to improve operating standards in Colombia. Passion
Growers provides a number of support programs for its
employees at zero or nominal cost. Croitoru noted one in
particular that enables employees to complete their formal
education and another that provides pre-school for their
children. The company’s Ipanema farm was recognized in
2011 as a “Great Place to Work” by Great Places to Work
Institute Colombia, which evaluates and ranks businesses.
In addition, organizations including Asociación Herrera,
the Untraflores union, the House of Flowers, Corporación
Cactus and CorpoLabor provide services and support to
women in the industry.
The Colombian flower sector has been successful because
of international demand. It has managed to attain this level
with little government involvement. However, to continue
to thrive, the industry needs more government support
and better working conditions. Despite its long history,
this industry still has a long way to go before becoming the
largest in the world.
This article was written by Sebastian Apud, Gennadiy Babenko,
Bobby Gianchandani and Mizuho Imanishi, members of the
Lauder Class of 2017.
27
The Global Oil Industry and Africa’s Role in Its
Future
The gas and oil industry has always been complex and challenging. The current state of the
sector is marked by price volatility, the adaptation of new technologies and the lingering
question of the role of certain African nations in oil production.
In 2015, the world witnessed one of the most important
collapses in oil prices in recent history. Less than 200 days
after the beginning of the decline in June 2014, the price
of crude had been cut roughly in half, rapidly changing the
business scenario for multiple actors in the complex value
chain that dictates the pace for the oil and gas industry.
Trend 1. Even though oil price declines may
not last, players will have to continue to
deal with volatility in prices.
Many oil-exporting nations were exposed to significant
revenue shortfalls, while consumers in petrol-importing
countries enjoyed lower costs for driving their vehicles.
Companies focused on exploration and production (E&P)
have since been forced to restructure their business models
and strategic investments, whereas players in the refining
business are benefitting from an unexpectedly competitive
price for their main product.
has not, creating price volatility and a challenging scenario
for oil companies. Shale oil produced in the United States
will continue to exert upward pressure on the global
supply. By drastically reducing the need for oil imported
into the U.S. and forcing producers to look elsewhere
to compensate, U.S. shale oil has also created a war for
market share in Asia — one that will likely lead to sustained
downward pricing pressure in the region.
Governments in resource-rich
countries face an increasingly
urgent need to make their domestic
petroleum industries as competitive
and investment-friendly as possible.
More than a year has passed since prices began to drop, yet
there remains a high level of uncertainty about the future of
oil prices. Companies that are active or looking to operate
in the oil and gas industry today need a comprehensive
awareness of the present environment. In particular, an
examination of three major trends is necessary to better
understand the oil industry today. Six more factors outlined
here are important in order to determine whether, given
the current political and economic environment, Africa
represents an attractive opportunity or dangerous risk for
companies in the oil and gas sector.
28
In the near to medium term, analysts see little reason to
expect a significant or sustained recovery in oil prices.
Indeed, the oil supply has been increasing while demand
According to Goldman Sachs, the successful reserve
additions since 2009 from both deepwater and shale
projects have transformed the cost curve, which now
encompasses more than three times the future peak
production from new giant fields that the investment bank
had expected in 2010. Over the years, the uptick in U.S.
onshore activity has led to greater learning-curve effects,
resulting in geological improvements and efficiency gains
that in turn have unlocked a vast amount of reserves once
deemed economically unfeasible. In addition, U.S. shale
production has driven the large oil supply growth over the
past years. U.S. shale production also played a significant
role in the collapse of oil prices since the first half of 2014.
In addition to U.S. oil production, non-OPEC supply growth
also boomed in 2014. According to Goldman Sachs, all
of the resulting extra supply contributed to a perfect
storm, with record production from U.S. shale, the longawaited ramp-up of the Santos basin and a normalization
of years of very poor delivery in mature offshore regions
including the North Sea, the Norwegian Continental Shelf
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
and the Campos basin. These combined factors drove oil
production up 2 million barrels per day on a year-over-year
basis.
On the OPEC side, production was flat over the course of
2014. However, this statistic masked two divergent trends:
consistently strong growth in Saudi Arabia and continued
volatility in production in the rest of OPEC (where Iraqi
production growth made up for a year-on-year decline
in Libyan production). Saudi production has consistently
ranged between 9.5 million and 10.3 million barrels per
day since May 2013, with higher production seen during
the summer months to meet greater domestic demand.
Data from Goldman Sachs show Saudi production topping
10 million barrels per day in March 2015 – earlier than in
previous years – thereby suggesting that the country is
building oil stocks in order to feed refining additions seen
in the country during the previous 18 months. According
to the Boston Consulting Group (BCG), Saudi Arabia
is OPEC’s most critical player because it holds 72% of
the organization’s current spare production capacity.
Moreover, Saudi Arabia seems quite content to let the
market self-correct due to a belief that a period of stress
for marginal producers and high-cost projects will lead to a
more stable and sustainable pricing environment over the
longer term.
Meanwhile, on the demand side, Asian economies
continue to face weaker-than-expected demand growth,
contributing to the plunge in oil prices and further stalling
a recovery. More traditional oil-consuming markets such as
Europe continue to struggle against recession, and many of
the financial weapons employed to fight the crisis, such as
quantitative easing and a decrease in interest rates, have
already been used. That means positive surprises for oildemand growth are improbable, at least in the short term.
According to oil-market experts from BCG, oil demand
may face even more downside pressure in the future
due to improvements in energy efficiency, the increasing
substitution of natural gas for oil in the transportation
sector and the increasing implementation of carbonemission targets. All of these factors taken together will
likely cause the volatility observed in current oil prices to
continue for a period of time.
Growth Strategies in a Global Economy
Nevertheless, this context may create new opportunities
primarily in the merger and acquisitions sector. New
petroleum resources remain in the hands of a few, while
some companies have excess cash due to a lack of research
and oil-prospecting investments in the pipeline. Goldman
Sachs highlights as potential buyers companies with low
financial leverage but high project costs that can use their
solid balance sheets to gain access to lower-cost projects
currently only in the hands of companies that have high
financial leverage. Such deals can potentially change the oilmarket dynamics around the world, including in Africa.
Industry experts seem to have
differing concerns and opinions
about recommending Africa as an
attractive opportunity for today’s
major multinational oil-and-gasexploration players.
Trend 2. Structural supply constraints
should continue to put upward pressure on
investment and operational costs.
It is important to note that subsea exploration and
production are not considered novel activities. Roughly 54
years after the first subsea production well was installed
by Shell Oil Company in the Gulf of Mexico, and despite
great technological progress made in the sector since
then, the industry is now facing important new challenges
related to its maturation. A study conducted by BCG
shows that, while subsea oil installations typically are
designed to last 20 years, multiple regions of the world
have producing wells that are on average more than 10
years old. This indicates that many production areas are
operating with equipment that is approaching the end
of its design. Choosing to repair this aging equipment
often means choosing between investing in replacements
or performing costly maintenance interventions. The
latter option presents a particular dilemma for operators
because as technology has progressed rapidly over the
past five decades, so have the many technical specifications
29
for equipment and installation tools. A mismatch in
adaptability of older and newer specifications can generate
technical bottleneck inefficiencies and high maintenance
costs for these operators.
Trend 3. Governments are expected to be
increasingly influential as both players and
regulators in the sector.
Governments in resource-rich countries face an
increasingly urgent need to make their domestic petroleum
industries as competitive and investment-friendly as
possible. Many of them (e.g., Norway and Canada) rely
heavily on oil revenues to fund their budgets, and the
sudden drop in price has pushed many countries into deficit
status and posed sudden risks to government stability.
Policymakers will need to become more innovative and
creative in designing policies to incentivize long-term
petroleum investment in such a volatile environment.
Indeed, the policy paths governments choose to manage
the current situation will ultimately have a significant
impact on the long-term dynamics of the global petroleum
industry.
Government involvement in the petroleum industry is
looking far beyond regulation and incentivization, however.
In recent years, state-owned enterprises have become
increasingly prolific across the world. Some notable
examples include Petrobras (Brazil), Statoil (Norway),
Gazprom (Russia), Saudi Aramco (Saudi Arabia) and the
many state-owned petroleum firms in China, such as China
National Offshore Oil Corporation (CNOOC), Sinopec
and China National Petroleum Corporation (CNPC).
A salient point has been the increasing role of African
governments in actively managing their respective oil
resources. National oil companies and sovereign wealth
funds have been developing across the African continent.
Even though such initiatives are certainly vulnerable to
corruption, they show an increased willingness on the part
of African governments to diversify their economies (to
prevent Dutch disease implications) and “level the playing
field” with foreign entrants through joint ventures and
partnerships with local entities.
In addition, rising environmental and social pressures
around the world will increase the role of governments
and other stakeholders. New norms in corporate social
30
responsibility (CSR) are reshaping the balance of power
between oil companies, governments, nongovernmental
organizations and communities, and the instantaneity
of today’s communications will help ensure that, from a
public relations perspective, CSR will remain central in
international corporate strategy.
Opportunities and Challenges for Africa
In the face of the compounded effects of old and new
challenges, industry players must continue to search
for new opportunities in different geographies across
the globe. At the same time, most experts agree that
the majority of the older, easier-to-drill oil fields are no
longer up for grabs. New supplies often prove costly and
are generally difficult to find. An analysis of hydrocarbon
discoveries between December 2011 and June 2013,
conducted with data collected by the oil and gas upstream
consulting firm IHS, shows that most new opportunities
are located in regions that are considered politically and
economically unstable, with roughly 25% of the discoveries
announced during that period located in West and East
African countries. The continent’s growing value to the
industry is also demonstrated by data from the U.S. Energy
Information Administration (EIA), which show that 12
African countries had proven oil reserves of more than 500
million barrels by the end of 2012, and four of them held
more than 10 billion barrels at the start of 2013.
According to Ernst & Young, even though only a fraction of
Africa’s mineral resources is being extracted, the continent
has 8.6% of the world’s proven oil reserves and 7.2% of its
natural gas. Industry reports commonly include West Africa
in the so-called “Gold Triangle,” alongside Brazil and the
Gulf of Mexico, to indicate world regions that will dominate
oil extraction expenditure over the next five years.
Moreover, deepwater gas discoveries in 2014 in regions
such as East Africa have helped to propel the African
continent into the center of discussions about future oil and
gas opportunities. But operating in less explored and more
politically unstable geographies such as Africa not only
amplifies the aforementioned challenges but also brings
new risks into the equation.
Industry experts seem to have differing concerns and
opinions about recommending Africa as an attractive
opportunity for today’s major multinational oil-and-
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
gas-exploration players. These experts express varying
observations and predictions about the conditions in
which these companies find themselves today and of the
strategies they may choose to employ in a time of crisis.
However, it is possible to highlight six common points in the
discourse about relevant risks such companies will likely
face if they choose to enter Africa.
First, there is the risk of political conflict. A company must
be prepared to face instability and uncertainties in dealing
with local governments. Instabilities generally translate
into contract defaults in the form of bid annulments,
unforeseen tax increases and contract revisions.
Companies will also likely have to develop local cultural
and linguistic capabilities if they wish to succeed. As noted
by Marcos Gallotti, vice president of Geonunes, a privateservices company that has served operators in Western
Africa exploration blocks, “to do business in countries like
Benin and the [formerly Belgian] Congo, it is absolutely
imperative to have knowledge of the local law policies and
cultural habits. Knowing not only how to understand your
counterpart, but also how to read the nuances in their (sic)
discourses are necessary tools in any negotiation, and this
is especially true in dealing with governments in Africa.”
Second, there is the risk of local conflicts and violence.
According to Gallotti, many of the less expensive
opportunities in Africa are onshore, often requiring that
supporting infrastructure, or even day-to-day operations,
pass through multiple inland regions that are undergoing
conflict. Adding to the complexity, onshore exploration
often demands the use of explosives that are also sought as
contraband. There are additional costs to bring these tools
into the country of operation and also to protect them from
theft. The resurgence of piracy attacks in African waters
has prompted additional serious concern in the industry.
The International Maritime Organisation (IMO), a global
maritime watchdog, has estimated that West African
countries lost just over US$1 billion in oil revenue in 2011
due to piracy.
Third, the costs of logistics in the region are high.
Onshore opportunities on the continent require large
capital investments in Africa’s currently underdeveloped
infrastructure. However, even for offshore operations,
the governments often enforce strict laws favoring
Growth Strategies in a Global Economy
local suppliers. Many African countries still have
underdeveloped supply chains, thus amplifying the risk of
delays in delivery and project management and significantly
impacting operational costs.
Fourth, there is a shortage of highly skilled labor. Access to
a skilled workforce is challenging in many parts of the world
— Africa included — particularly in highly technical fields
such as engineering and geophysics. At the same time,
many African governments are tightening local content
rules and forcing companies to hire a significant percentage
of their workforce from the local population. Not only do
such requirements create a key operational cost issue for
companies — developing training programs can be capital
intensive and take decades to accomplish, and companies
often resort to paying above-average salaries for scarce
talents — they also present a unique and somewhat
perplexing management phenomenon. As one French oil
industry insider noted, “Several European engineers on my
team were astonished to discover that they were earning
less than their African peers. This created an irrecoverable
imbalance in the morale of the group.”
Fifth, petroleum companies need to adapt to the
complexity of managing environmental impact laws.
Negative impacts of the oil industry are a major concern
globally, and Africa is no exception. For example, in 2013
Angola introduced a zero-gas-flaring policy, and the South
African government announced clean fuel legislation.
Public and official concerns about exploration for shale
gas by means of hydraulic fracturing have highlighted
the environmental risks associated with the industry,
and this heightened awareness is expected to result
in more stringent environmental regulation, requiring
additional expenditures for environmental management
and protection by oil and gas companies. However, some
experts continue to believe there is an opportunity for
major companies. The fact that African governments still
have nascent regulatory structures arguably opens space
for companies to participate and influence decision-making
that may benefit their operations or, at least, minimize the
negative impact.
Sixth, there are competing global business models at
play. In particular, Chinese oil companies have entered
Africa with a completely new model that intertwines the
31
extraction business with aid commitments, credit lines and
infrastructure investment. China first entered the African
petroleum landscape through Sudan in 1996, at a time
when Western companies were hesitant about inserting
themselves due to the nation’s political instability and poor
human-rights record. Such issues posed no barrier to China,
however, and the country has since reproduced this model
throughout the continent in Angola, Nigeria, the Republic
of Congo and Gabon. China’s strategy — informally called
“petro-diplomacy” by its critics — is based on five key ideas:
preserving direct control of the petroleum resources
in order to contribute to China’s controlled domestic
development, not hesitating to pay more than the market
price to fund long-term resource acquisitions, forming
privileged partnerships with African national oil companies,
focusing on ways to increase technical capacity and knowhow and abiding by a “no-judgment” policy on human rights
and corruption. In comparison, the primary differentiating
factors of Western entrants are their higher sensitivity to
CSR and more developed technical capacity — the latter of
which still represents an important advantage, according to
experts. Going forward, Angola will provide an interesting
study of the efficacy of the two divergent business models,
32
as both Western and Chinese entrants are present and
highly active in the country.
Conclusion
In order to operate in the oil and gas exploitation industry,
companies must be ready to face a set of important
challenges dealing with price volatility, supply constraints
leading to higher operational and capital costs, more active
presence of governments as players and investors, and
increasing pressure from environmental and social laws. As
newer and easier opportunities become increasingly harder
to find, Africa appears to be a potential way forward for
companies looking for growth. Although Africa amplifies
many of the challenges of the petroleum sector and adds
further complications for companies that want to operate
on the continent, it is clear that there are still opportunities
to seize. It will be interesting to see how exactly these
trends and beliefs develop and materialize in the coming
years.
This article was written by Caio Guimarães, Imran Karim and
Alexandre Nogueira, members of the Lauder Class of 2017.
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
Colombia’s Informal Sector
An informal economy, composed of unlicensed, unregistered businesses that do not pay taxes,
is a challenge for any country. The informal sector in Colombia is especially difficult because it
represents such as significant portion of the economy.
In many developing countries, informality is a key economic
concern and accounts for a significant share of economic
activity and employment. According to the World Bank, the
“shadow economy” in Latin America averages 40% of the
gross domestic product, and more than 50% of the labor
force is informal. This is typified in Colombia, a country that
also faces other complex and pressing challenges including
terrorism, deficient infrastructure and high regional
economic inequality. Moreover, informality can hinder
economic development. Challenges associated with the
informal sector of the economy include the government’s
inability to collect sales and income tax revenue, the lack or
insufficiency of quality and safety standards, and the dearth
of good jobs for the country’s citizens.
During Colombia’s most recent period of strong economic
growth, the size of the informal sector declined. Research
has shown a positive correlation between growth in gross
domestic product and formalization, but this also implies
a retreat in formal activity during economic downturns.
Therefore, relying solely on economic growth to reduce the
size of the sector will have limited and temporary results.
Additional political, social and cultural factors must be
addressed in order to discourage informality.
Definition of the Informal Sector in
Colombia
The informal sector is distinguished from informal
employment, as undeclared work can exist within formal
enterprises. The International Labour Organization (ILO)
of the United Nations defines the informal sector as a
set of small-scale enterprises that have a rudimentary
organization and do not distinguish between labor and
capital as factors of production. These informal companies
are not registered according to national laws, including
commercial regulation and social security laws, and
their employees are not covered by labor legislation. In
Growth Strategies in a Global Economy
addition, the informal sector does not include underground
production, illegal production or household production
for its own use. It is often difficult to measure directly
the size of the informal sector. In Colombia, the National
Administrative Department of Statistics (DANE) estimates
the informal sector through surveys of micro enterprises,
which are defined as establishments with up to 10 people
employed through trade, services and industries. The
survey instrument considers a business to be formal when
two requirements are met: commercial registration with
the government and a set of accounting books and records.
Several benefits are associated with
formalization, including increased
access to capital and greater support
from the government.
Impact of Economic Growth on Informality
The size of the informal sector moves in a countercyclical
fashion with regard to official economic growth. Over the
last few years, Colombia’s informal economy has grown
during recessions and declined during economic booms.
According to an ILO report on the country’s formal and
informal sectors, the countercyclical movement of the
informal sector can be seen as an indication that GDP
growth and informality follow an inverse relationship.
The report explains that, in a recession, companies lay off
employees, which in turn increases the unemployment rate.
These newly unemployed workers open companies without
registering them with the government as a means to save
on costs and regulatory burdens. According to the DANE,
in 2007 only 43% of micro enterprises were registered
legally and only 53% maintained accounting records. By
33
2013, the latest year for which data are available, these
figures increased to 72% and 71%, respectively. During
this same period, Colombia’s GDP increased from COL$
431,072 billion (US$207 billion) to COL$710,257 billion
(US$380 billion). As the data suggest, throughout the latest
economic boom, informal companies have formalized,
registering with the Colombian government and
maintaining accounting books and records.
Key Factors Leading to Formalization
It is clear that, on a macroeconomic level, informality is
correlated negatively with economic growth. However,
on a microeconomic level, firms analyze the benefits
and costs of formalization and weigh each factor based
on their individual operations and priorities. As a result,
firms may reach different decisions about formalizing. In
addition, many firm owners are unaware of the benefits of
formalization or have misperceptions about the process
that influence their decision making.
In a country with low GDP per
capita and low disposable income,
consumers may be more willing to
sacrifice quality over price.
Several benefits are associated with formalization,
including increased access to capital and greater support
from the government. According to a 2009 statistical
study by Mauricio Cárdenas Santa María, the director of
Fedesarrollo, a Colombian think tank focused on economic
and social policies, and Sandra Rozo, Inter-American
Development Bank research fellow, informal firms have
more difficulty obtaining credit. As a consequence, they
acquire capital primarily from moneylenders, relatives or
friends. Another benefit of formalization is the support,
such as consulting and counseling, offered by the chambers
of commerce to small businesses and the advantages that
the government grants to small and medium enterprises
(SMEs), such as tax exemptions, reduced administrative
procedures and priority in public bids. Despite these
advantages, a 2010 DANE survey showed that 53% of
34
informal business owners were satisfied and had no plans
to change their business structure. Of this group, 83% cited
excessive paperwork as a reason to remain outside the
formal sector and 65% indicated they did not understand
the benefits of formalization.
Several key burdens are associated with formalizing. The
first is taxation. According to the World Bank, over 20%
of companies with fewer than five employees and 10% of
companies with more than 100 employees in Colombia do
not report their sales. The 2015 Ease of Doing Business
report shows that the taxation level in Colombia reaches
the equivalent of 75% of income, which is particularly high
when compared with the 48% rate in other Latin American
countries. This extreme level is driven by high payroll taxes,
so jobs tend not to offer adequate guarantees for health
and pension benefits. Cárdenas and Rozo conducted focus
groups with business owners who stated that companies
can spend less to bribe officials and remain informal as
opposed to formalizing and paying taxes. Another cost
derives from poor institutional quality. Many businesses
avoid formalization because they believe the money the
government would receive through taxes would never
return to benefit the businesses. A study by Friedrich
Schneider, professor of economics at the Johannes
Kepler University of Linz in Austria, showed that the lack
of efficiency in providing decent public services can be
associated with higher shadow economic activity.
Finally, a strong cultural component creates a low-threat
environment. According to Gustavo Adolfo García Cruz,
a postdoctoral research fellow in economics at the
Universidad de Los Andes in Bogotá, informality is widely
accepted by society and Colombians do not hesitate to
frequent such businesses. For example, many citizens
routinely eat at food carts that have not been formally
registered. This could be due to the endemic distrust of the
government and its institutions. Another hypothesis could
be derived from microeconomic and marketing theories:
The lower prices offered by the informal sector (tax- and
regulation-free) may provide a significant competitive
advantage. In a country with low GDP per capita and low
disposable income, consumers may be more willing to
sacrifice quality over price.
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
In summary, businesses do not value equally the benefits
and costs, and they will reach different conclusions about
whether to formalize. The costs to follow this route are too
high for some, while others do not have full information
about the benefits.
The Role of Public Policy
Economic growth is often not sufficient to reduce the
informal sector and informal employment. As a result, the
government can play a role in educating companies about
the benefits of formalization, connecting them to available
resources, reducing the costs of formalization (payroll,
income taxes and the required paperwork) and regulating
companies. In recent years, the Colombian government has
made decreasing the size of the informal sector a priority
in several ways, implementing new laws and public policies
and making changes to key programs for micro, small and
medium enterprises (MSMEs).
First, the government has promoted business formalization
through legislation. The Micro, Small, and Medium Business
Law, enacted in 2000, established national councils that are
responsible for ensuring the creation and implementation
of public policies that support MSMEs. The law also created
tax incentives for their creation, including periods of
exemption, lower rates and reductions in contributions
during the first three years of operation. The Formalization
and Generation of Employment Law, passed in 2010,
further reduced the regulatory burden on small enterprises
and simplified administrative procedures.
Second, the size of the informal economy is correlated with
elevated tax rates. A 2014 study by Jesús Rodríguez de
Luque, research associate at the International Center of
Tropical Agriculture, suggests that a government’s public
policies can reduce the informal sector through tax and
regulation policies. In 2013, the Colombian government
implemented a tax reform that reduces an employer’s
payroll contributions in cases where a worker’s salary does
not exceed 10 times the minimum salary. The ILO estimates
that this reform led to a 13.5% reduction in employers’
payroll contributions.
Third, the Colombian government has also implemented
various initiatives to reduce the level of bureaucracy
Growth Strategies in a Global Economy
encountered when registering a business, to connect
enterprises with sources of credit and investment,
and to disseminate information about the benefits
of formalization. By 2013, 30 Centers of Attention
to Businesses had been established throughout the
country to reduce the amount of paperwork required
and the number of different government agencies to
be contacted to register a business. Prior to that, the
National System of Micro, Small, and Medium Businesses
was created in 2004 to incentivize formalization through
credit guarantees, lines of credit through Bancoldex (a
bank for entrepreneurial development) and access to
formal financial services in locations that lacked formal
banking services. Finally, the government introduced
the Colombia Formaliza (Colombia Formalizes) program,
which disseminates information about the benefits of
formalization and helps businesses that are looking
to formalize through lines of credit from Bancoldex or
nonrefundable financing through the iNNPulsa MiPyme
and Emprendedor funds, among others.
In recent years, the Colombian
government has made decreasing
the size of the informal sector
a priority in several ways,
implementing new laws and public
policies and making changes to
key programs for micro, small and
medium enterprises.
Even though Colombia has implemented many laws,
public policies and programs to promote the formalization
of MSMEs, few studies have evaluated the impact of
these policies. As a result, it is difficult to determine their
quantitative effect on the reduction of the informal sector.
In addition, it is important for the government to establish
a strong system of regulation and enforce sanctions to
encourage formalization. According to professor Gustavo
Adolfo García Cruz of Universidad de Los Andes, the lack
35
of government regulation encourages informality. Without
the threat of credible punishment, many businesses
continue their informal operations. In contrast, García
Cruz referenced the case of Ecuador, which has created a
government ministry to prosecute and penalize informal
companies or entrepreneurs and has subsequently
experienced a drastic reduction in the level of informality.
Does Microfinance Encourage
Formalization?
In its 2011 development plan, Colombia’s Ministry of
Finance and Public Credit recommended microfinance
as a method to encourage the formalization of micro
businesses. In recent years, due to support from the
government and other sectors, growth in microfinance
has accelerated. In 2007, microfinance institutions (MFIs)
had a combined loan portfolio valued at COL$2 billion
(US$1 million), which increased to COL$8.7 billion (US$4.6
million) by 2014. Today, Colombia’s microfinance sector
is the largest in Latin America, serving 1.9 million people.
However, while the establishment of microfinance should
help reduce the size of the informal sector, the evidence
suggests otherwise.
The rationale for supporting microfinance to encourage
formality stems from the assumption that funds will be
used to grow a business and that such growth will allow,
and sometimes require, the business to formalize itself.
However, this assumption is flawed for a number of
reasons. Most importantly, access to capital has been one
of the main drivers in a small business’s desire to formalize.
With the introduction of microfinance — a legitimate and
comparatively easy way to access credit — many businesses
find they no longer require formalization to attract needed
funds. In addition, as noted above, many business owners
lack the willingness to formalize their enterprises. Even
for those who want to formalize, very few MFIs offer
additional services to clients to help them understand the
process.
No studies have shown the effect of microfinance on the
formal sector in Colombia. However, studies from other
countries help shed light on the relationship between
microfinance and the size of the informal sector. A World
36
Bank study by Miriam Bruhn and Inessa Love, published in
2014 in The Journal of Finance, is particularly revealing. It
shows that the opening of one MFI branch in a community
in Mexico was related to a 7.6% increase in the number
of informal local businesses in one year and no change
in the number of formal businesses. Furthermore,
the income of micro businesses in the informal sector
increased by 7% over the same period, diminishing the
incentive to formalize. While few resources in Colombia
have attempted to gauge this impact, many organizations
promote microfinance. Future studies should measure
the percentage of MFI clients that have formalized their
businesses and investigate whether additional services
offered by an MFI, such as education on the formalizing
process, lead to higher rates of formalization.
More Work Ahead
In many developing countries, the informal economy is an
important component of economic activity, but one that
also has detrimental effects on economic development.
In Colombia, the size of the informal sector moves in
tandem with the country’s economic growth. When a
significant portion of economic activity is not formalized,
the government is faced with lower tax revenues, and a
considerable percentage of the population is left without
benefits such as health care programs and retirement
savings. While benefits from formalization include
increased access to capital and government support for
small businesses, many enterprises view the costs as
too high or lack full information about the process. The
Colombian government is taking steps to reduce these
roadblocks in an effort to encourage small and midsized
companies to formalize. However, without rigorous studies
that evaluate the results of government policies and
institutions, it is hard to determine their impact. Future
research should be undertaken to understand the most
effective government programs and to prioritize initiatives
effectively.
This article was written by Frank Ballard, Rafael de la Rosa,
Craig Jones and Monica Scheid, members of the Lauder Class of
2017.
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
TECHNOLOGY CHANGES EVERYTHING
Second-generation Ethanol Production in Brazil:
A Historic Opportunity
Brazil has been the historical leader in the production of ethanol ever since Portuguese settlers
derived alcohol from sugarcane in the 16th century. The newest iteration of ethanol production,
known as 2G, holds the promise of greater efficiency and profit margins — if companies can
surmount the challenges.
In 1532, Portuguese settlers in Pernambuco, Brazil,
extracted alcohol from sugarcane for the first time. Today,
Brazil produces 27 billion liters of ethanol from sugarcane
each year. In the early 1920s, when the United States was
dismantling the Standard Oil Company, the governor of
Pernambuco ordered that all vehicles run on ethanol. This
singular history of fuel in Brazil is particularly relevant in
light of the sensitive current debates on sources of energy
for vehicles and how to reduce carbon emissions.
Amid one of the most critical economic crises in Brazil’s
history, the development of second-generation (2G)
ethanol could be a tremendous source of economic growth
and power as well as advance the country’s environmental
responsibility. As philanthropist and entrepreneur Louis
Glickman once said, “The best investment on earth is earth.”
With a 25% global market share, Brazil is the secondlargest ethanol producer in the world behind the U.S.
While the latter relies on corn for its ethanol production,
the former focuses on sugarcane. Ethanol as a fuel source
originated in Brazil in the early 20th century but did not
Growth Strategies in a Global Economy
gain traction until the 1973 oil crisis and the resulting
Programa Nacional do Álcool, or PROALCOOL. This program
accelerated government and private investment in
bioethanol production, making it the centerpiece of Brazil’s
energy sector.
The environmental benefits
of ethanol relative to other
combustible fuels have positioned
Brazil as a leader in the alternative
fuel space.
The 2003 introduction of flex-fuel vehicles (FFV) capable
of running on both gasoline and hydrous ethanol rapidly
became the standard for Brazil’s vehicle fleet. By 2014,
FFVs accounted for 88% of new light vehicle sales and
cemented the economic viability of a domestic ethanol
37
market. The environmental benefits of ethanol relative to
other combustible fuels have positioned Brazil as a leader
in the alternative fuel space.
environmentally friendly than 1G, utilizes more of the plant
and has higher conversion yields. This results in less waste
and an improved carbon footprint.
However, recent developments highlight additional
challenges for Brazil’s ethanol industry. The 2007
discoveries of pre-salt petroleum reserves off Rio de
Janeiro’s coast and the 2015 tumble in oil prices shifted
momentum away from ethanol. From a supply standpoint,
first-generation (1G) processing is starting to show signs
of maturity. During 2013-14, only three new ethanol
factories were built, compared with 30 during 2008-2009.
Conventional production yields are stagnating at about
6,000 liters per hectare.
According to a study conducted by Foreign Policy, ethanol
production in Brazil averted the production of 600 million
tons of carbon between 1974 and 2004. This has given
Brazil the clout to influence negotiations on environment
policy, such as during the Sustainable Innovation Forum
held at the Conference of Parties (COP21) in Paris in
2015. Jeremy Rifkin noted in his book, The Third Industrial
Revolution: How Lateral Power Is Transforming Energy, the
Economy, and the World, that, “In practice, many South
American countries have been slow to wean themselves off
fossil fuels. Brazil, the continent’s economic powerhouse,
is an exception. It generates 84% of its electricity from
renewable hydroelectric power, and domestic ethanol
makes up between 20% and 25% of every liter of petrol
used in transport.
The potential for 2G ethanol is
huge, and the increased resource
efficiency makes it an innovative and
socially responsible industry worth
following closely.
Enter 2G ethanol production, which relies on both
technological-process improvements and raw-material
innovation to achieve significant gains in efficiency. Since
2011, Brazilian companies have invested heavily in the
development of 2G technologies. If successful, these
advancements, combined with Brazil’s relative cost
advantages and ample arable land, have the potential to
radically transform the country’s role in the global ethanol
market.
How 2G Ethanol Works
The primary difference between 1G and 2G ethanol
is the input. The process for 1G converts the natural
sugars in crops such as sugarcane, corn and sugar beet.
2G production is relatively input-agnostic — it can be
manufactured from a wide-range of biomass, be it corn
or sugarcane variants. However, some input materials
are more yield-efficient and potentially more costeffective than others. Overall, the 2G process is more
38
The strong reliance on hydroelectric power and plantbased ethanol makes Brazil one of the most advanced
renewable energy economies in the world.” Today, Brazil’s
edge provides a very strong advantage in the global
economic competition and geopolitical game.
2G ethanol production is more efficient and eco-friendly
than the 1G process. Collection of the input material is
simple. For example, farmers allow employees of biotech
company GranBio onto their lands after harvest to collect
the straw left on the field. The gatherers pay according to
the weight collected. The real challenge lies in the requisite
time frame between the harvest and the collection, which
is generally 7 to 10 days. Thus, 2G ethanol production
facilities need to be close to the collection fields, resulting
in logistical and infrastructure constraints.
The efficiency gains from using the waste are considerable:
The same area planted can generate up to 50% more
combustibles. A key point is that 2G ethanol is exactly the
same as 1G ethanol, with no difference in usage or energy
output. However, 1G ethanol production is 30% more
expensive. This is due to the enzymes used to degrade the
sugar in the straw or molasses. Even though prices fell
78% in four years, the enzymes still represent a significant
proportion of the production costs.
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
The 2G production process also has greater potential for
profit. Currently, a batch of enzymes can be used only once.
The industry is working on creating enzymes that survive
and can be reused over many production cycles. This would
reduce the price and improve competitiveness, important
factors in a global-energy landscape where oil is cheaper by
the day.
However, many observers have become disillusioned with
an industry that is not delivering on its forecasts. The
industry as a whole is experiencing large-scale difficulties
with the production process. Indeed, GranBio and its
competitors in Brazil, Italy, China and the U.S. have been
unable to achieve and maintain stable production. With
teams working nonstop on the issues, these companies
are certain that success is near. 2G ethanol’s potential
is huge, and the increased resource efficiency makes it
an innovative and socially responsible industry worth
following closely.
The 2G ethanol conversion process employs enzymes to
break down the woody lignin of the plants. An optimal
fermentation for producing 2G ethanol requires steam pretreatment of the leaves and bagasse (plant residue after
juice is extracted) and an enzymatic hydrolysis. Two major
innovations have generated substantial enhancements in
the production process. First, enzymes are now integrated
in a more productive conversion process. An article
published in Brazil in 2015, “Biotechnology for Biofuels,”
noted that a 55% increase in enzymatic conversion
generated a 25% increase in sugarcane biofuel yield.
Second, enzymes purchased by laboratories are now largely
reusable. This has resulted in significant decrease in the
marginal cost of producing 2G ethanol.
Pushing the Boundaries of Technology
One of the most fundamental changes about 2G ethanol
is the use of cellulose in lieu of sucrose. Cellulose is the
primary structural component of green plants, some algae
and other organic life. Because it is ubiquitous across nearly
all plant life, the options for deriving ethanol utilizing a 2G
process are exceedingly input-flexible. By implication, this
flexibility opens an expansive set of options to engineer
input stocks that are higher in cellulosic content while
allowing for crops tailored to particular environments.
These crops, called energy crops, are genetically
Growth Strategies in a Global Economy
engineered to have favorable traits including high yield and
resiliency. Various platforms are being developed around
the world using base plants such as grasses, trees and, in
the case of GranBio, sugarcane.
To date, GranBio has invested over $300 million to develop
a genetically modified energy sugar crop called Cana
Vertix, commonly known as energy cane. According to
the company’s website, energy cane was developed by
genetically crossing commercial sugarcane hybrids with
ancestral types of sugarcane in a combination that, like
other energy crops, maximizes biomass production rather
than the production of sucrose. In addition, GranBio has
engineered favorable traits into the cane, allowing it to
thrive in more extreme climates that are traditionally illsuited for sugarcane cultivation.
Today, with applications from general
energy to the plastics industry, 2G
ethanol’s potential appears more
and more important.
The robust nature of this cane and its enhanced growing
cycle make it, on paper, the perfect 2G fuel stock. It can
be cultivated in areas that are currently not being put
to productive use with traditional sugarcane. A study
completed by Granbio shows that, in Brazil alone, energy
cane could be planted across 32 million hectares of
degraded pasture land — an area larger than all of Europe’s
current arable farmland.
As GranBio looks to scale up production, it faces several
key challenges common to the development of nearly
all genetically modified organisms. GMO plants in Brazil
are heavily regulated, often with onerous requirements
and extensive timelines for approvals. Any new GMO
product, whether for human consumption or for cultivation
for energy, requires assessments of the risks to both
humans and the environment. However, one element
works in GranBio’s favor: Sugarcane is cultivated in areas
where the climate does not allow the plant to produce a
flowering body. This reduces the risk of unintended crossbreeding between the GMO plant and the natural stock of
sugarcane.
39
This is one of the reasons the native platform of energy
cane has been categorized as a Class 2, or low–risk,
GMO product. Even so, the approval process for a new
modification takes at least 18 months. This poses a
substantial bottleneck in GranBio’s development cycle for
2G ethanol and is another example of how this product’s
future in Brazil is deeply intertwined with the regulatory
framework. As GranBio looks to reinvent the ethanol space
through a 2G process, it will clearly look to energy cane to
achieve many of the economies of scale it needs to make 2G
ethanol a profitable substitute for both ethanol and other
traditional fossil fuels.
During the 20th century, gasoline monopolized energy
production for transportation purposes. All the negative
effects of this monopoly — from the Standard Oil Company
to the war in Iraq — hampered the development of a
competitive market for other energy sources. In the 1970s,
following the oil shock, the Brazilian government decided to
invest heavily in the production of bioethanol derived from
sugarcane, one of the country’s main agricultural resources.
The progressive destruction of the gasoline monopoly will
40
generate a substantial surplus for consumers, a shift in the
geopolitical landscape and positive externalities for the
environment. These outcomes will be reinforced by biofuel
ethanol mandates around the world that are pushing for a 5
to 10% ethanol blend for use in all combustible vehicles by
2020.
Today, ethanol appears to have far greater potential beyond
being an efficient energy source for cars. Historically, in
Brazil it has aimed to be versatile and universal. The father
of ethanol production in the country, João Bottene, who
was a contemporary of Nikola Tesla, invented a locomotive
that could operate on alcohol energy, the Fúlvio Morganti,
and several boats that could run on the same energy.
Today, with applications from general energy to the plastics
industry, 2G ethanol’s potential appears more and more
important. It could be a unique opportunity for Brazil and
the global energy landscape.
This article was written by Jeff Aziakou, Casey Dwyer, Typhaine
Robert and Stephane Fisch, members of the Lauder Class of
2017.
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
How the U.S. and China Each Nurture Innovation
Innovation thrives when intellectual property is protected. Here is a look at how innovation is
flourishing in two very different places: South Carolina and China.
From ancient battles to the Industrial Revolution, history
is filled with examples of how technological advantage
drives a country’s economic and political success. But
an active approach towards developing an innovation
system is something that governments have engaged in
only somewhat more recently. In the late 20th century,
academics began discussing the role of innovation policies
and defining actors who shaped innovation systems.
What is an innovation system? Shannon Brown, dean
of faculty and academic programs at the Dwight D.
Eisenhower School for National Security and Resource
Strategy in Washington, D.C., explains that it is based
on the following pillars: a system of patents protecting
intellectual property (IP) that can be enforced in the courts,
an affordable and effective system of national universities
where research can take place, and a business-financing
system that supports the spending necessary for research
and development. In the United States, the public and
private sectors together have shaped some of the world’s
most successful innovative companies, from Boston to
Silicon Valley.
Dating back to the 1790s, patent protection is among
the oldest laws in the U.S. While it has given rise to some
controversial cases — such as the rivalry between Antonio
Meucci and Alexander Graham Bell over the telephone or
the dispute between George Selden and Henry Ford over
the automobile — the American IP-protection law has given
investors and inventors the motivation to finance risky
R&D ventures that would not have attracted sufficient
financial backing. (For a more recent example of a patent
that has given rise to heated debate over its enforceability,
consider the case of Vertex and its recently approved
$259,000 drug to treat cystic fibrosis).
The other protagonists in the U.S. innovation system
are venture capitalists (VCs). While often downplayed
as secondary actors, it is impossible to split VCs from
Growth Strategies in a Global Economy
technology companies in successful innovation hubs. While
there have been many attempts to replicate the Silicon
Valley ecosystem or the Boston medical technology scene,
it could be argued that the unique combination of access to
human and economic capital is the secret ingredient that
makes these two innovation hubs unique.
However, this is not the only possible model of innovation
development. In Turkey and China, for example,
governments act as the primary promoters of technology
parks, bridging the gap between a thriving academic scene
and a still-nascent financing industry. At the same time,
academic research has shown that while public incentives
for developing innovative technology can leverage the
mobilization of large-scale capital, the private sector can
better respond to changing market dynamics.
In the United States, the public
and private sectors together have
shaped some of the world’s most
successful innovative companies,
from Boston to Silicon Valley.
On a different note, does the interaction between the
government and the private sector shape the direction
that an innovation system will take? In the U.S., when
making an investment decision, an institutional investor
normally ascribes significant weight to whether a
company’s competitive advantage is protected by a patent.
In countries with a different IP protection structure, the
presence of a patent does not hold the same importance.
This does not preclude innovation from flourishing,
although the types of companies and technologies that
are financed and developed will be different and greatly
affected by the IP protection present in a given country.
41
Drawing examples from the U.S. and China, this paper
illustrates how a country’s IP rights influence how investors
think about their opportunities and how innovation
develops as a result. The cases are from the South
Carolina Research Authority (SCRA) and HAO Capital, a
Chinese private equity fund. Conclusions are drawn from
numerous meetings, online research, phone interviews and
professional experiences.
The U.S.: South Carolina’s Crisis Resolution
During the 1970s and ‘80s, the U.S. textile-manufacturing
industry lost much of its competitive edge to cheaper
labor in overseas markets. Many textile plants in South
Carolina closed and moved to China and Japan, creating a
devastating scenario for the state. In 1983, in response to
the rising need to find another lifeline for the economy, the
state of South Carolina established SCRA with a founding
grant of $500,000 and 1,400 acres of undeveloped land.
Figuratively situated between academia and government,
this applied R&D nonprofit bridged a critical gap by
investing in tech startups and matching businesses and
academic organizations to government projects. According
to SCRA’s website, the agency’s cumulative output
into South Carolina is more than $19.5 billion since its
inception, and it has helped create 15,000 jobs with annual
salaries between $55,000 and $79,000.
South Carolina is a clear example
of how strong IP protection makes
the U.S. a hub for innovation and
research.
SCRA started out by identifying inconsistencies in supply
management within the defense and aerospace industry.
The team it formed for this area focused on product and
process development. According to SCRA staff, its teams
have always believed that the science behind the projects
was protected under a strong IP structure. This fact was
crucial to extending the network of SCRA’s enterprise
partners. As a result, SCRA benefited not only from deeper
42
relationships with universities but also from a broader
network of clients, primarily in industry and government.
Investors soon appreciated the environment that was
emerging in South Carolina, and strong foundations
were built for what is recognized today as long-standing
strategic partnerships. There are more than $4.5 billion in
active contract value of R&D portfolios; over 250 projects
underway in the Department of Defense consortium, which
has funded $1.2 billion in applied research to date; more
than 300 high-tech jobs that have benefited from over $78
million in funding and infrastructure; and over $280 million
invested directly and indirectly in startups.
SCRA attained an important milestone in 1992 when it won
a competition to lead a consortium formed by McDonnell
Douglas, Grumman, General Dynamics, Boeing, Northrop
and Lockheed Martin to collaborate on the development
of specific product-data standards. The SCRA-led team
interacted across multiple companies and industries.
Boeing, the Eurofighter and the U.S. Air Force are among
the thousands of clients that today use the standards
developed by this group. Certainly, this wouldn’t have
been possible without the right mix of IP, R&D and finance
systems.
Investing in science can make a difference for development.
South Carolina appears to be committed to policies that
promote long-term well-being over fast and short-term
growth. SCRA has been clear in this regard: Investing
in knowledge has led to great strides in understanding
complex problems. This wouldn’t have evolved without
a strong IP system in place to protect investments.
Replicating a successful environment such as SCRA is
difficult. No doubt, South Carolina is a clear example of how
strong IP protection makes the U.S. a hub for innovation
and research.
China: A Unique Innovation Route
Mirroring South Carolina’s design, the Chinese
government’s ambitious national innovation policy and
improvement of its IP law have played pivotal roles in
transforming the country from being simply a copycat
factory to an emerging hub of innovation. According to
VCs there, the national innovation systems are strongly
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
affected by the importance of IP in investment decisions.
With an increasing number of VCs investing in high-tech
sectors, a healthy cycle that promotes innovative culture
should be established that will further complement China’s
national innovation system.
The Chinese government’s innovation policies comprise a
series of top-down strategies that encourage breakthrough
innovation. Over the last 40 years, the government has
issued a series of policies aimed at stimulating innovation.
In the early 1980s, the country established the National
Natural Science Foundation of China (NSFC), a state-level
lab program, to fund university research projects. The
NSFC has enjoyed strong support from the government,
and its annual budget increased by an average of 21% in 15
years.
In 2006, the government issued a “Medium-to-long-term
Plan for the Development of Science and Technology”
(MLP) in which it declared its intention to transform the
country into “an innovative society” by 2020 and a world
leader in science and technology by 2050. In addition to its
efforts to promote domestic innovation, the government
(with its immense foreign-exchange reserves) has been
encouraging Chinese firms to acquire leading technologies
from overseas. Currently, the official plan is to balance
the foreign direct-investment inflow and outflow by 2015
and to encourage outbound mergers, acquisitions and
expansion by private companies.
Even though China’s efforts to promote innovation have
shown a positive impact, its IP law needs improvement.
First, there is a large gap between the copyright law and
the requirements to promote copyright industries. Second,
the country’s patent laws still need improvement in the
areas of transparency of the approval process, rewards
for employment invention and enforcement measures in
cases of infringement and abuse of patent rights. Two case
studies exemplify how the national innovation and legal
systems have affected the importance of IP in investment
decisions and how companies innovate and protect IP in
China.
TCL Healthcare: Investment Based on a Strong Sales Capability
TCL Healthcare is a joint venture between TCL
Corporation, a Chinese consumer-electronics giant, and
Growth Strategies in a Global Economy
HAO Capital, a $600 million private equity fund in China.
Its primary business is manufacturing diagnostic imaging
equipment, which requires a large R&D investment. When
HAO Capital decided to invest in TCL Healthcare in 2012,
the latter had only eight mid-end X-ray patents registered
in China.
Nevertheless, HAO Capital’s investment team placed a
high value on its wide distribution channels and financial
strength. To strengthen TCL Healthcare’s patent portfolio,
HAO Capital, as a precondition for investment, reached an
agreement with other company board members to pursue
an IP acquisition strategy. Following the investment, TCL
Healthcare reached a number of technology-licensing
agreements with leading medical device companies so
that improved products could be sold through its national
distribution channels. This is a classic example of how
Chinese investors value the strength of sales capability (i.e.,
distribution channels and market share) over patents when
companies don’t have strong technological advantages.
The Chinese government’s
innovation policies comprise a
series of top-down strategies that
encourage breakthrough innovation.
LP Amina: IP as a Key Precondition for Investment
LP Amina is a Beijing-based company that specializes in
deNOx, a technology that reduces the amount of polluting
nitrogen oxides in the air. When Qiming Ventures, a
leading Chinese VC fund with $1.7 billion in assets-undermanagement, invested in its series A round in 2008, the
company developed its proprietary Low NOx Burner
De-NOx technology in its U.S. lab without any registered
patent. Qiming evaluated the technology and affirmed
its potential to become a force in China’s environmental
efficiency market. However, concerned about weak IP
protection there, it encouraged LP Amina to retain its
R&D function in the U.S. and file patents in both the U.S
and China. This ensured Qiming’s strong protection of the
company’s technology and ability to commercialize it in
both markets.
43
As these case studies illustrate, Chinese VC funds have
developed their own way of capitalizing on opportunities
that China’s national innovation system has created, and
pursued creative strategies to avoid the consequences
of incomplete IP protection in the legal system. As the
country’s national innovation system develops further,
VC funds will be able to play larger roles in promoting
innovation.
The U.S. and China have taken different approaches to
developing a national innovation system. In both markets,
44
VCs play an important role in fostering innovation while
adapting to different IP protection regimes. There is no
fixed set of ingredients that a national innovation system
needs. Rather, the results of the interactions between
governments and private actors will determine the shape of
innovation in a given country.
This article was written by Antonio Muñoz, Gabriele Pigoli and
JungHa Yi, members of the Lauder Class of 2017.
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
Back to the Future? Germany’s Evolving Startup
Scene
Germany is nation that has never been short on brilliant ideas and innovation, but it is
struggling to keep up with the United States when it comes to nurturing startups.
A century ago, Berlin was the center of innovation. Known
as Elektropolis, it was the Silicon Valley of its time, world
famous for the profusion of electrical gadgets invented
by its local powerhouses. But a series of hurdles has kept
today’s German entrepreneurs from becoming bigger
and changing the world. The last German tech startup to
become a global star was SAP, which was founded in 1972.
The current question is: Will the recent innovation wave in
Berlin help the city regain its former status?
development and industrial processes. According to a
2013 article in The Economist, “the country’s oversized
trade surplus, its low unemployment rate and its thousands
of makers of machine tools, car parts and chemicals are
proof that it is keeping up with trends in industries in
which it excels.” So, there seems to be sufficient evidence
that Germans do have the mindset for innovation. Why
Germany is not yet home to a gigantic initiative such as
Google, Amazon or Facebook is not for lack of potential.
Germany rose from the ashes of World War II to become
a socio-political and economic powerhouse once again.
Compared to the other countries that comprise the G7,
Germany has by far the highest surplus on its current
account (+7.5% of GDP) as well as the second largest
savings ratio (26.3%). On the flip side, the country’s private
consumption ratio is moderate (56%) and its investment
ratio (18.9%) is at the lower end of the G7 spectrum.
Germany seems to be a capital-generator dynamo, but why
isn’t it investing its money?
Why Germany is not yet home to a
gigantic initiative such as Google,
Amazon or Facebook is not for lack
of potential. On the other hand, a
lack of finance seems to be a major
contributing factor.
The complexity of the German identity is evident in its
ability to be creative and highly efficient and organized —
all at the same time. According to British writer Stephen
Green, “There is no culture on the planet greater than
that of Germany. No country has contributed more to the
history of human ideas and creativity. No country has been
deeper into the abyss. And no country has seen a more
remarkable redemption and renewal.” In the business
realm, one bank notes that a new startup is founded every
20 hours, making Berlin a standout among the world’s
tech clusters. Bavaria, the country’s most prosperous
state, together with its neighbor, Baden-Württemberg, are
now home to hundreds of biotech, IT and environmental
technology firms that have emerged in the past 20 years.
With regard to the more traditional aspects of Germany,
the Mittelstand, or small- and medium-sized family-owned
firms, are highly innovative in terms of new product
Growth Strategies in a Global Economy
On the other hand, a lack of finance seems to be a major
contributing factor. Deutsche Bank estimates that the
number of capital investments in Germany is proportional
to the number in the U.S., or 11 to 12 per one million
inhabitants. However, it is becoming clear that the venture
capital market in Germany still has untapped potential that
needs to be released: Since 2012, €2 billion (US$2.2 billion)
of venture capital has been invested in young companies
in Germany, compared with €64 billion (US$69 billion)
invested in startups originating in the U.S. Moreover, the
average investment in Germany is €780,000 (US$840,300),
which is dwarfed by €6 million (US$6.5 million) in the U.S.
The Success of Rocket Internet
A key player in early-stage investing in Germany is Rocket
Internet, which focuses on creating versions of successful
venture ideas for other geographies or customer groups. In
45
October 2014, the Rocket Internet Group and Zalando —
its most successful venture — were responsible for two of
the largest technology-sector IPOs in Germany since 2000.
Several years ago, the founding Samwer brothers decided
to move into new markets and focus mainly on online
channels (e-commerce) as “the biggest trend worldwide,”
according to Oliver Samwer. The company is now present
in more than 50 countries, from Brazil to Pakistan. Key
components of its global strategy are speed and sharing
of resources. That is, the faster a new venture is launched
simultaneously in multiple countries, the better.
There are important differences in
innovation financing between the
U.S. and Germany. The U.S. is the
world’s uncontested leader in this
sector, while German companies still
lag far behind in creating digitalized
services.
Rocket Internet is often referred to as a copycat and is
known for its “‘growth-at-all-costs” culture. The firm
could be seen as a company-builder, as it launches similar
companies around the globe and keeps track of them by
collecting data and comparing the performances of sibling
ventures. This business model does not resonate with the
cool image venture capital firms tend to have. However, it
possesses something very German in terms of efficiency
and pragmatism.
selected startups and spends a significant amount of time
supporting their operational activities. It looks at three
aspects for a successful investment at an early stage: the
potential size of the business, the management profile and
skills (is the team the right one?), and proof of the concept.
This approach has definitely paid off, as the fund was able
to identify and invest in a number of successful Internet
companies, such as Zendesk, DeliveryHero, DocPlanner
and DaWanda. Recently, it raised its third fund, a new €52.6
million (US$60 million) fund that will be used to invest
mainly in Europe and North America.
In contrast to these successful and very satisfactory
ventures, Hasso Plattner Ventures, the venture capital fund
of the SAP software founder, has been struggling to find
deep technology startups in Berlin. It tends to invest in fastgrowing, IT-driven companies in Europe, South Africa and
the U.S. Hasso Plattner, the founder of SAP, is regarded as
one of the most important and influential IT entrepreneurs
alive, with numerous awards for his success in business
and science. Thus, his venture capital firm focuses on
sophisticated and highly innovative technology startups.
Yair Reem, one of the managing partners, claims it is very
hard to find such ventures in Berlin, as most startups there
are founded by people with business backgrounds and
aren’t technology driven. He claims that the majority of the
technology startups are in west and southwest Germany, in
cities such as Munich, Karlsruhe, Darmstadt and Stuttgart
— “close to the real industries.”
The Role of Banking and Government
Point Nine Capital is one of the few early-stage venture
capital firms born and based in Berlin. While investing in
Software-as-a-Service (SaaS), marketplace and mobile
startups internationally, the firm’s philosophy serves as a
contrast to that of Rocket Internet. According to Rodrigo
Martínez, an associate at the firm, “being an angel venture
capital means that we invest early and we try to be as
approachable, founder-friendly and supportive as an angel.
But with the deeper pockets of a venture capital fund.”
There are important differences in innovation financing
between the U.S. and Germany. The U.S. is the world’s
uncontested leader in this sector, while German companies
still lag far behind in creating digitalized services. Specific
examples demonstrate key aspects of the German
innovation-financing environment: Innovation is not
rewarded; innovation is scarce; and when checks are
written, they tend to be small. Furthermore, the local
savings banks and cooperatives that fund many traditional
companies are hesitant to lend to untested digital
entrepreneurs.
In practice, Point Nine Capital invests between €300,000
(US$342,000) and €1 million (US$1.14 million) in
Be it Microsoft, Facebook, Google, Apple or the latest
additions to the startup elite such as Snapchat, Slack,
46
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
Pinterest, Buzzfeed or Flipkart — all were founded in
the U.S. Through public funding of universities, the U.S.
government has helped to back innovation in Silicon Valley.
In 2014, Germany’s government passed a “Digital Agenda”
bill aimed at helping the country become a worldwide
leader in expanding high-speed data lines and Internet
security and fostering cyber-related entrepreneurship.
Among other results, the plan aims to increase the number
of newly established IT firms from the current annual rate
of 10,000 to 15,000.
German Minister of Economic Affairs Sigmar Gabriel
acknowledges the document does not have all the answers,
but IT has gained greater economic significance than the
auto industry. Despite the “Digital Agenda,” the German
government is still struggling to provide the necessary
domestic infrastructure, investment and legal-political
frameworks necessary for a future startup landscape that is
competitive with that found in the U.S. Germany’s current
key structural deficiencies remain limited state funding and
overall bureaucracies, such as a complex tax system and the
complexities involved in firing employees. “It took less time
to create a company in the U.S. than it did for us to open a
bank account in Germany for our business,” says Germanborn Florian Leibert, a former senior engineer at Twitter
and Airbnb.
Germany’s government also tries to help on the investment
side. KfW, the federal development bank, and other statelevel financial institutions finance innovation through
debt to new companies. The largest investor is High-Tech
Gründerfonds (HTGF), a semi-official venture capital
firm that draws investment capital from big German
companies (€574 million [US$618 million], 20%) and from
Growth Strategies in a Global Economy
the economic ministry (€2.3 billion [US$2.5 billion], 80%)
that writes checks of about €500,000 (US$538,650) in
exchange for a 15% stake.
Finally, Germany differs from the U.S. in one key aspect.
The German system and society despise and punish failure,
placing a burden on entrepreneurs and potential investors
who have a different, higher risk perception.
“It took less time to create a
company in the U.S. than it did for us
to open a bank account in Germany
for our business.”
— Florian Leibert
Europe’s largest economy holds the potential for a
promising trajectory regarding innovation. SAP was
the highlight of the IT sector several decades ago and is
still used as a reference, so there is track record. Rocket
Internet is already making enormous strides in terms of
execution, so there is innovation. Smaller funds such as
Point Nine Capital are out there making smart (and rather
small) investments, so there is intelligence. It is Germany, so
there is capital. What is lacking is the openness and ability
of formal institutions to embrace and promote failure. This
way, potential investors can acknowledge lower risk and
thus be more open to financing innovation.
This article was written by Stephanie von Staa, a member of the
Lauder Class of 2017.
47
WHY INFRASTRUCTURE IS IMPORTANT
Transportation Infrastructure Development in Asia:
A Comparison of Indonesia, Vietnam and China
As the middle class and number of city dwellers swells, traffic congestion has quickly become
a top concern in the world’s most densely populated cities. A comparison of the problems and
solutions in Indonesia, Vietnam and China illustrate the difficulties and show how a road less
traveled could lie ahead.
The modern airport in the Indonesian capital of Jakarta
makes a good first impression on visitors. However, that
positive impression usually ends on the 16-mile bus ride
from the airport to downtown. Massive gridlock on the
eight-lane highway keeps traffic moving at a snail’s pace,
making the short trip take up to three hours.
With many rising economic
centers and thousands of miles of
incomplete [transportation] lines,
Southeast Asia remains a lucrative
market for all infrastructure
development companies.
Southeast Asia is one of the most vibrant and fastestgrowing regions in the world. With rapid economic growth,
an expansion of manufacturing sectors and exploding
48
urbanization rates, countries in the region face increasingly
critical challenges from inadequate transportation
infrastructure.
In contrast, China, Southeast Asia’s powerful neighbor
to the north, is an infrastructure-advanced country
and a major investor and supplier for transportationinfrastructure projects around the world. An examination
of governance structure, land-acquisition processes and
funding resources reveals important lessons about the
drastic differences in infrastructure development across
Indonesia, Vietnam and China.
Indonesia: Struggle and Stagnation
Jakarta is the most populous city in Southeast Asia, and
every day about 1.38 million commuters travel there from
its surrounding area, known as Jabodetabek. Jakarta has
long been notorious for its traffic jams. In 2015, the CastrolMagnatec Stop-Start Index, published by British motor-oil
company Castrol, ranked it among cities with the worst
traffic in the world, where drivers idle about 27% of the
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
time. The congestion stems mostly from a lack of adequate
public transportation – in quality and quantity — which
encourages people to take private vehicles. Currently,
more than 70% of the vehicles on the road in Jabodetabek
are privately owned, and every year about 13% of publictransit users shift to private transport.
The existing public transit system comprises mostly
minibuses that offer almost no safety and little comfort.
In 2004, the TransJakarta Bus Rapid Transit (BRT) system
began operations with the objectives of providing residents
with fast public transport and reducing rush-hour traffic
jams. However, a number of logistical problems have made
it difficult for the system to meet its initial goals, including
the lack of a feeder system and other vehicles occupying
dedicated bus lanes. To address these problems, in 2013
the government began construction of a light rail Mass
Rapid Transit (MRT) system, with Phase 1 planned for
completion in 2018.
Suharto, the second president of Indonesia, ran a highly
centralized government that created a number of
socioeconomic issues, including corruption, collusion and
inequality, according to many observers. After his forced
resignation in 1998 amid a sweeping Asian financial crisis,
Indonesia experienced years of decentralization. Today it is
the third-largest democratic country in the world.
While this decentralized system accords more autonomy
to local governments, it proves to be less effective
in coordinating among different stakeholders in
infrastructure projects.
One example is the Jakarta monorail project, which began
in 2004, was abandoned in 2008, resumed in 2013 and
was abandoned again in 2015, mainly because the city
administration had doubts about the contractor’s ability
to fund the project. According to Jonathan Pincus, adviser
in economic affairs at Transformasi, a Jakarta-based think
tank, the land around the monorail stations will become
more valuable after the project’s completion, and the
government could establish a mechanism to capture part of
that profit by agreeing to terms with the land owners. The
additional revenue could then be used to build the actual
infrastructure. But instead, the government’s failure to
coordinate between the public and private sectors resulted
in a funding shortfall for the monorail project. A similar
issue has also affected the current MRT project.
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The legal framework of property ownership also creates
an obstacle for infrastructure construction in Indonesia,
particularly in the land-clearance process. The current
land law dates to the 1960s, and in remote parts of the
country there is a combination of modern property rights
and communal rights. As a result, land ownership is often
unclear. Different parties may claim ownership of the
same piece of land, leading to confusion and disputes. The
long and costly process of land clearance has delayed the
progress of Jakarta’s MRT construction.
Government and politics
obviously play important roles in
transportation infrastructure.
The first, pre-construction phase of the MRT project
was funded through a loan by the Japan International
Cooperation Agency (JICA). In March 2009, the Indonesian
government and the JICA signed Loan Agreement 2 (LA2)
for ¥48,150 billion ($400 billion), which was forwarded to
the Jakarta City Administration as a grant. This latter group
will offer two more proposals to the central government for
additional loans in lieu of grant agreements.
In addition to the financing component, the Indonesian
government has invited various international companies
to participate in the construction process. India-based
Delhi Metro Rail Corporation has been awarded work in
the form of management consulting services on the Jakarta
MRT system, as part of a joint venture with eight other
international companies. In 2015, subway trains for the
north-south line were ordered from Sumitomo, a Japanese
company.
In addition to the efforts to build public transportation
infrastructure, the government has also taken measures
to limit the use of private cars, including the “3 in 1”
carpooling mandate in congested areas during rush
hour. At the beginning of 2015, President Joko Widodo
decided to abolish the gasoline subsidy to free up funds for
infrastructure projects, which also discouraged privatevehicle usage to some extent.
49
Vietnam: Growing Problems, Emerging
Solutions
Even though Vietnam was reunited under communist rule
in 1976, brutal wars during the preceding decades had
destroyed most of its transportation infrastructure, and its
economy remained depressed. Beginning in the late 1990s,
the country’s liberalization policies began to have a positive
impact, and the economy has grown steadily since then. But
economic growth has led to exponential population surges
in Vietnam’s cities, where chronic congestion often grinds
traffic to a halt.
Jakarta has long been notorious for
its traffic jams. The congestion stems
mostly from a lack of adequate
public transportation, in terms of
both quality and quantity, which
encourages people to take private
vehicles.
As Vietnam’s economic hub, Ho Chi Minh City has
witnessed a number of modernization efforts within the
transportation infrastructure. One notable example is the
new terminal at Tan Son Nhat International Airport. Begun
in 2002, construction was completed in 2007 with help
from the Japanese Official Development Assistance (ODA).
Vietnam relies heavily on air travel, and the new terminal
handles two-thirds of the country’s international flights.
Another important project is the Ho Chi Minh City Metro,
first proposed in 2001. Construction began in 2012, and
service is expected to start in 2020. The city’s historical
core, with its extremely high population density, has seen
relatively little population growth in recent years, while
growth in the suburban areas has soared. The metro is
expected to connect various neighborhoods and alleviate
the current motorbike-dominated quagmire.
Government and politics obviously play important roles
in transportation infrastructure. Compared with China
50
and Indonesia, Vietnam’s political environment seems to
blend elements of both and is somewhere between the
two systems. On one hand, Vietnam has a centralized party
structure for decision making, similar to that of China. On
the other hand, political fragmentation and rivalries among
various ministries and regional governments more closely
resemble Southeast Asian realities found in Indonesia.
For example, a key obstacle in any large public project is
land rights and clearance. In Vietnam, the government in
theory owns all the land and grants use rights to individuals
under different terms and stipulations. Government
officials also have been known to hand out personal
favors or profit from usage-rights changes, adding further
difficulties to each project. In Ho Chi Minh City, however,
the local government, given its more limited and defined
scope of responsibilities, has been better able to manage
competition among contentious factions. Early squabbles
over land and contracting rights for the metro project were
settled by the city government, and conflicts have been
more manageable during construction.
Unlike China, which actively sought to add foreign
expertise to local industrial capabilities, Vietnam does not
have a grand plan to develop local heavy manufacturing
to the same degree of self-sufficiency. Compared with
China, Vietnam’s state-owned industry was never quite as
developed to begin with and currently does not run a large
trade surplus. So, the binding constraint is almost always a
need to find capital for technology acquisition and physical
construction. Even though Vietnam’s economic growth has
been impressive over the last 20 years, it is not yet realistic
for the country to establish a large heavy-industries sector
in the near term from developments in transportation.
Both the Tan Son Nhat International Terminal and the Ho
Chi Minh City Metro are funded primarily by the Japanese
ODA. Indeed, this agency is an essential funding source
for many of Vietnam’s infrastructure projects, of which
about 90% have long-term (30-year plus) loans at near-zero
concessionary rates, with the remainder comprising free
grants and technical assistance.
The Japan International Cooperation Agency (JICA), the
central agency that manages the Japanese ODA, has a
strong influence during a given project’s initial discussions,
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and local governments negotiate with the JICA on
contracts between local and Japanese manufacturers. After
the contract distribution is set, the local government takes
control and owns the entire project upon completion, with
the Japanese contractors fulfilling only maintenance duties.
Even though concessionary loans appear to be great deals
for Vietnam, they also complement Japan’s own industrial
strategies. Since many of these loans flow back to Japanese
manufacturers, the ODA helps Japan maintain its industrial
base. In addition, the metro project is a stepping stone for
Japan to export its rail standards to the entire Association
of Southeast Asian Nations (ASEAN). With many rising
economic centers and thousands of miles of incomplete
lines, Southeast Asia remains a lucrative market for all
infrastructure development companies.
While the JICA sometimes proposes projects on its own, Ho
Chi Minh City’s government devised the master plan for the
metro first and pitched it to potential aid agencies around
the world. The city government managed most of the
negotiations, with the national ministries of transportation
and finance in the background granting approvals. This
approach led to better administration of the project.
The general lack of public-transportation infrastructure
in Ho Chi Minh City, aside from the aging and increasingly
unreliable bus network, has led to widespread use of
motorbikes. This, in turn, has caused chronic congestion,
worsening pollution and a rising number of accidents.
With the city’s frontiers expanding outward, the local
government is striving to build infrastructure to ameliorate
deteriorating traffic conditions. Vietnam is sure to grow
with more maturity and confidence in the future.
China as a Potential Example for Others
The expansion of China’s modern infrastructure began
after its economy opened in 1978 and accelerated after the
early 2000s, when the country prioritized improvements
as a way to promote growth and bridge widening regional
and urban-rural disparities. China undertook construction
of its first controlled-access expressway in 1984 and its
first high-speed railway in 1999. Today it has a national
expressway system that surpasses the interstate highway
system in United States in terms of total length, and the
largest high-speed rail network in the world.
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During the same period, China has made equally impressive
progress in urban transportation systems. In 1995, only
Beijing, Shanghai and Tianjin had working subway systems
comprising merely one to two lines each. Twenty years
later, Beijing and Shanghai boast the world’s two longest
metro systems, and 22 cities across China now have
modern urban metro systems. Sixteen more will have them
by 2020.
Compared with Indonesia and
Vietnam, China has significantly
more internal funding available for
infrastructure projects.
The strongly centralized communist government
has helped China effectively plan and execute its
infrastructure-development projects. China’s railway
system is controlled almost completely by the National
Railway Bureau, which has managed all major railway
expansion since 2008, according to the State Council’s
Mid- to Long-Term Railway Development Plan. In the area
of urban metro transportation systems, even though local
governments plan and manage construction and operation,
all construction, upgrades and equipment expansions
must first receive approval from the powerful National
Development and Reform Commission (NDRC) before
proceeding. With these mechanisms in place, the central
government effectively coordinates and guides the overall
development of transportation infrastructure at both the
national and regional levels.
In addition, the ease of land acquisition under China’s
current political system facilitates construction of
infrastructure projects. As all land in China is state- or
collective-owned in theory, the government has absolute
authority in its expropriation of it. Once a project is
approved by the relevant government agency and receives
funding, local authorities can usually manage to finish land
clearance by preset deadlines.
Compared with Indonesia and Vietnam, China has
significantly more internal funding available for
51
infrastructure projects. Initially, it also utilized ODA funding
from Japan and other foreign loans for its infrastructure
projects. In fact, ODA funding supported some of the most
prominent infrastructure projects during the early 2000s,
including China’s first high-speed rail system, which was
completed in 2003, and the major expansions of Beijing’s
and Shanghai’s airports about the same time.
However, in recent years the massive infrastructure
expansions in China have been mostly self-funded by
the government and domestic sources as the country’s
economy and wealth have grown rapidly. Railway
expansion, for example, has been funded primarily with
central and local government allocations as well as
domestic bonds issued by the National Railway Bureau. For
example, an important source of the recent surge in railway
investment came from the central government’s US$600
billion stimulus package in 2008, which earmarked a large
portion for high-speed rail expansion.
China’s focused industrial policies supporting domestic
production of transportation equipment and systems play
a key role in facilitating its expansion of transportation
infrastructure. While it initially needed to acquire
technologies from abroad, China had clear plans to use the
power of its market to exchange for the transfer of certain
key technologies it lacked. It then incorporated these
technologies and developed its own industrial capabilities
in relevant transportation systems and equipment.
For example, in recent years, the NDRC has requested
52
that at least 70% of the system equipment for all newly
approved metro projects in China be manufactured
domestically. These new Chinese technologies,
controlled by large state-owned enterprises such as
the CRRC Corporation, helped to further reduce the
costs of construction, operations and maintenance of
transportation infrastructure. Furthermore, these large
state-owned enterprises are also expanding beyond China.
On the urban transport front, in 2014 the CRRC won the
contract to supply Boston’s MBTA subway system. On the
high-speed rail front, China is now competing with Japan
for every new planned project around the world, with the
most recent being in Indonesia.
Even though neighboring countries in Southeast Asia
need the infrastructure expansion that China was able
to achieve in the past decades to support their growing
manufacturing-based economies and improve living
standards, key differences in government structure and
funding can make China’s experience difficult to replicate
elsewhere. However, with the country now becoming
a more active funding source — through its Asian
Infrastructure Investment Bank and its One Belt, One
Road initiative — and a provider of cheaper equipment
and systems, neighboring countries may be able to take
advantage and accelerate their lagging infrastructure
improvements.
This article was written by Xinlong Cheng, Yifan Li and Ivy Wu,
members of the Lauder Class of 2017.
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
Favelas: Brazil’s Lingering Infrastructure Problem
Imagine living in a place so dangerous that the electric company won’t send in crews to fix the
infrastructure or provide the most basic of services. That’s what life is like for people living in
the slums, or favelas, of Brazil’s second-largest city, Rio de Janeiro.
Favelas, or shantytowns, figure prominently in Brazil’s
landscape and in the collective consciousness of its
people. Before 2008, when the government undertook
a community policing effort known as pacification to
clean up the slums, access to the entire spectrum of basic
public utilities (water, electricity, waste disposal, etc.) was
limited in nearly all of Rio de Janeiro’s favelas. With rival
gangs vying for territorial control in the city’s poorest
neighborhoods, utility companies refused to service areas
where the state could not ensure the integrity of their
infrastructure and the safety of their employees.
Those living in Rio’s favelas devised access to the electricity
grid via a gato — a wrench inserted manually into power
lines to divert electricity into residents’ homes and
businesses. The gato raised the risk of electrocution,
short circuits and sudden fires from electrical surges. It
also symbolized the city’s inability to service its poorest
neighborhoods. Moreover, the city’s main electric utility,
Light Serviços de Eletricidade S.A. (Light S.A.) ultimately
became the primary supplier of electricity — officially and
unofficially— to its favelas.
The widespread use of the gato became a critical driver
for Light S.A.’s economic losses in 2013. Stolen electricity
amounted to R$1.5 billion (US$500 million) or more than
5,200 GWh — about 15% of the private company’s yearly
electric distribution capacity. By way of comparison,
electricity stolen from Light S.A. across the entire city of
Rio was equal to the yearly electric consumption of the
state of Espirito Santo, home to over 3 million people.
Maintenance was also impacted adversely by the illegal
electric installations: In 2013, 76% of the damage suffered
by the utility’s electric transformer infrastructure was due
to energy surges in areas known to have gatos.
In addition, Light S.A. faced significant challenges in billing
clients in certain communities because safety concerns
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precluded in-person collection and payment of invoices.
This resulted in staggering non-technical electric losses
and default levels in low-income communities of 64.1% and
90.4%, respectively.
From a social standpoint, the issue of electric-service
availability was equally daunting. Stealing electricity in
Brazil is a crime that carries a sentence of one to four years
in prison. Of the 120 people the courts of Rio sentenced in
2012 for utilizing gatos, many might have been forced to
steal electricity given Light S.A.’s inability to build sufficient
infrastructure to service their communities.
One of Light S.A.’s most intriguing
and innovative social-inclusion
programs is Light Recicla (Light
Recycles), a recycling-centered
sustainability program with a billcredit component.
Light S.A. Finds a Solution
As noted, it was impossible for Light S.A. to serve
customers properly in the favelas. After the Pacifying Police
Units (UPP) successfully began to occupy and guarantee
security in these communities in 2008, the utility was
able to address the challenges of not only creating a new
relationship with favela residents, but also incorporating
them as legal consumers of — and payers for — electric
service.
Light S.A.’s priorities revolved around modernizing electric
infrastructure in the communities (power distribution
lines, transformers, etc.), identifying and eliminating gatos
53
and generally regulating electric consumption in the
areas. Since 2008, the utility has implemented several
projects promoting company-community relationshipbuilding and education on sustainable energy use. For
example, the company’s Comunidade Eficiente, or Efficient
Community project, focuses on rewiring private homes
in the favelas, swapping old electric bulbs for more
efficient versions and replacing kitchen equipment, such
as refrigerators, to reduce energy waste. Travessia, or
Journey, is another project in the favelas sponsored by the
state government and BNDES, Brazil’s development bank,
that aims to revitalize sports and leisure spaces for favela
residents. This complements Light S.A.’s other communityand relationship-building efforts, which include art and
cultural development projects such as Favela Criativa
(Creative Favela) and Intercambio juventude-Arte (Youth Art
Exchange).
Light S.A’s recycling model has been
a real success story. The program
has grown from three recycling
centers in 2011 to 14 in 2014.
One of Light S.A.’s most intriguing and innovative socialinclusion programs is Light Recicla (Light Recycles), a
recycling-centered sustainability program with a bill-credit
component. This project follows a national trend among
private recycling companies that has made Brazil one of the
top recyclers of aluminum cans, among other materials, in
the world. Inspiration and empowerment also came from
the success of Coelce, the electric company of the state
of Ceara, which pioneered the exchange of recyclables
for discounts on electric bills. Launched in January 2007,
Coelce’s Ecoelce project offers discounts to any client
who brings in waste to be recycled. The results have been
astonishing: As of July 2015, more than 430,000 registered
clients had helped to recycle over 18,000 tons of waste
through 100 collection points across the state, generating
savings of R$2.5 million (US$800,000).
54
Building on Coelce’s experience, Light S.A. decided to focus
on only residents of favelas and low-income communities
when it launched its recycling program. The pilot was
created in August 2011 and offered to nearly 4,000
residents in Rio de Janeiro’s first pacified favela, Santa
Marta. Its social-impact principles included alleviating
poor sanitary conditions resulting from piled-up garbage
and establishing an economic “escape hatch” to facilitate
the payment of electric bills and to decrease the default
rate among existing customers. To put these challenges in
perspective, prior to pacification in 2008, there were 1,597
houses in the favela, of which only 24 of the 73 receiving
electric bills actually paid.
In that sense, the recycling program has been a real
revolution. According to Fernanda Mayrink, Light S.A.’s
community outreach officer, it “encourages recycling
within the company’s concession area and at the same
time contributes to sustainable development and the
consumer’s pocket. Light S.A. wins, the customer wins [and]
the environment wins.”
The Light Recicla model has three sets of constituents:
the residents, the recycling companies and Light S.A.,
which serves as the intermediary. From the residents’
point of view, the recycling flow is very user-friendly
and transparent. First, they need to register at one of
the recycling centers for an “ecocard” — a type of credit
card — that is used to record discounts electronically each
time they deliver waste for recycling. They can then start
collecting and bringing clean and categorized waste to
one of the 14 favela recycling “ecopoints” to accumulate
credit electronically on their card. Finally, they can decide
how to use that credit — either by donating it to one of the
48 registered institutions (e.g., schools, hospitals, social
groups or nongovernmental organizations) or by applying a
discount to their own electric bills.
Light S.A. has several partners that help at different stages
in the process. 3E Engenharia coordinates registration for
the ecocard, and Coopama and the NGO Doe seu Lixo are
the recycling companies that purchase the collected, clean
and categorized material.
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The materials Light Recicla has been receiving include
metal, plastic, paper, glass and vegetable oil. Credits have
ranged from R$0.10 (US$0.03) per kilo of paper and plastic
to R$2.50 (US$0.90) per kilo of aluminum and lead. For
very proactive residents, the amount credited can cover
or even exceed their monthly bills. In an interview with
TheEcologist.org, Mayrink told the story of a Santa Marta
resident identified only as Severiano who has not paid a bill
since the program began and has saved R$1,256 (US$ 400)
that he is putting into an account for his son.
A Program with Impact
Light S.A’s recycling model has been a real success story.
The program has grown from three recycling centers in
2011 to 14 in 2014. As of December 2014, more than
13,000 residents had registered in the 14 favelas with
centers, recycling more than 2,717 tons of material and
11,500 liters of vegetable oil. The company has also
received a number of environmental protection awards,
such as Environment Action 2014 from the Industry
Federation of Rio de Janeiro, Engie Brasil for Innovation
2015 and the sixth award of the Business Association of Rio
de Janeiro for Sustainability.
The recycling-for–a-discount initiative has been adopted
by other electric companies in the Brazilian states of São
Paulo, Ceará, Pernambuco, Maranhão, Bahia and Rio
Grande do Sul as of 2014.
From a financial standpoint, participating favela residents
are saving an average R$40 (US$15) per month on electric
bills that normally range from R$80 to R$120 (US$25 to
US$40). That translates into roughly a 33% savings that
can go up to 100% for the most disciplined consumers. At
the same time, households are not the only stakeholders
gaining a financial benefit. Many institutions such as local
hospitals, schools and child care centers are receiving
donations through Light Recicla. For example, the electric
bill for a samba school for children in the Santa Marta favela
has been reduced by over R$500 (US$160) per month
through the program. Such savings are crucial for these
communities, considering the limited budgets families tend
to live on.
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One of Light S.A.’s biggest problems – even after the UPP
pacification – was user default rates on unpaid electric
bills. Under the Light Recicla model, the revenue source
for these payments is covered by material purchases
from the recycling companies. This allows Light S.A. to
reduce repayment and collection risks significantly, while
minimizing end-user electric-bill costs. In addition, Light
S.A has arranged off-take agreements with market-based
adjustments for the purchase price of recyclable material,
ensuring that the utility’s costs for and revenues from the
program (i.e., electric-bill discounts vs. sales proceeds from
materials) are balanced.
In Santa Marta in the past, the waste
produced by the neighborhood was
usually thrown into the streets and
accumulated in rivers and channels.
Financial savings are possible only through the energy
saved by recycling. Using recycled material instead of
typical production materials saves a considerable amount
of energy because manufacturing companies can use
the recyclables as a base for their production, instead of
starting from scratch. The 13,000 clients registered in the
program in 2014 collected enough material to save 10.6
GWh of energy, equivalent to the consumption rate for
4,800 households. Thanks to this program, favela residents
are now more aware of the cost of the electricity and use it
more cautiously. This has had a direct impact on emissions
related to electricity production, as Light S.A.’s programs
have curbed consumption patterns in Rio de Janeiro.
Rio is one of the most beautiful cities in the world, but it is
also among the 10 dirtiest, as reported by Globo television.
In Santa Marta in the past, the waste produced by the
neighborhood was usually thrown into the streets and
accumulated in rivers and channels. José Mario, president
of the residents’ association, stated in a recent interview
that Light Recicla drastically changed the pollution
55
situation in his community. Light S.A.’s recycling site for
Santa Marta alone is collecting 800 kilograms of waste
per day, and the reduction in trash has freed up rainwaterdischarge channels and decreased the amount of waste
that is pulled toward the bottom of the favela on rainy days.
All these changes are having a tremendous social impact.
People who lived in communities dominated by crime
and overrun with weapons and drug trafficking are now
becoming active citizens. Light Recicla is also a learning
process that is making residents more aware of the
problems in their favelas. Jerson Kelman, the president
of Light S.A., notes that Light Recicla represents a new
commitment by community residents to the company and
themselves. Everyone is hoping for a cultural change that
56
will bring a better quality of life to the city and its residents,
he said.
Light S.A.’s efforts to promote and establish social-outreach
programs in low-income communities throughout Rio de
Janeiro have clearly begun to pay dividends. The win-win
model of economic growth, coupled with the environmental
stewardship offered by Light Recicla, is an outstanding
example of the company’s success in building relationships
with the communities it serves while fostering the social
integration of Rio de Janeiro’s most forgotten inhabitants
with the rest of the city.
This article was written by Christine Burq, Joel Filippi and
Guillermo Nemirovsky, members of the Lauder Class of 2017.
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
Living in the Shadows: How Rural Workers Pose a
Challenge to Chinese Urbanization
In Beijing, a million people live in underground housing units, mostly rural workers seeking
cheap rents. China, which wants to shut down these homes, is grappling with these and other
challenges from urbanization.
Two stories beneath a mixed-income residential building in
the Haidian district is a collection of dark, musty corridors,
exposed wiring and damp laundry that form one of 3,000
underground communities in China’s capital, Beijing.
Down deep in these former bomb shelters, noise from the
crowded streets above becomes a whisper. Narrow white
Shizi explains that, despite the poor lighting, communal
bathrooms and other negative aspects of living
underground, she feels it is a safe place to live. Moreover,
she points outs the lack of options within a reasonable
commute to her internship. Many of her neighbors in
underground housing are in a similar situation. For Shizi
hallways lead to about 10 dwellings, sized from 100 square
feet to 300 square feet, on each floor. Dusty pipes, tangled
wires, closed-circuit cameras and flickering fluorescent
lights line the ceilings. Garments hang outside red doors;
some doors are covered with thin, colored sheets — a
reminder of the different styles, ambitions and livelihoods
of the residents eking out a living under the city.
and her roommate, Beijing will provide the training and
prestige they need to accelerate their careers back in their
hometowns, and living temporarily in underground housing
is just a necessary part of realizing their ambitions.
Behind one of these doors lives a young woman who goes
by the pseudonym Shizi. She shares a small room of about
200 square feet with her classmate from a nursing school
in Hebei province. Like many aspiring young professionals
in China, they came to Beijing to seek job opportunities,
hoping to obtain professional training and work experience
at a nearby, top-tier hospital before returning home. Their
goal is to improve health care in their hometowns by
bringing leading medical practices to local hospitals.
Like most migrant workers in Beijing, Shizi and her
roommate have limited access to low-cost government
housing and receive little income from their internships.
Thus, moving into underground residences seems to be
the only affordable option for these and other young
professionals. According to Shizi, their combined rent
totals RMB 1,100 per month ($174), significantly less than
above ground rentals that typically exceed RMB 4,000 per
month ($634). These rental rates align with a 2014 study
conducted by Annette Kim, associate professor at the Sol
Price School of Public Policy at the University of Southern
California.
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An unprecedented pace of
urbanization, outdated government
policies and the city’s reputation
as a land of opportunity all led to
the flourishing of below-ground
communities.
Mr. Huo, who did not want to be identified by his full name,
is a successful entrepreneur in the publishing and education
business in Beijing who also once lived in a similar type
of underground residence in China’s Shanxi province. He
was drawn to underground housing as a graduate student
decades ago because it was both affordable and a quiet
place to study. However, the poor ventilation, high humidity
and lack of access to natural light –- which led to long-term
damage to his eyesight — forced him to relocate six months
later to an equally small but above-ground subdivided
apartment unit. At the time, he says, the cost of the aboveground rental and underground unit were fairly similar.
Based on his personal experience, Huo recognizes that
economic hardships can be a rite of passage for residents
57
born outside China’s major cities. Nevertheless, he
also supports the government’s plans to shut down
underground housing in Beijing. These residences, he notes,
are not only an image problem for China’s capital city, but
are also fundamentally unsuitable for living. He adds that
underground residents may not realize they are putting
their lives at risk in the event of catastrophes such as fires
or floods.
Government policies have both
exacerbated the challenge of finding
housing and helped establish the
underground spaces that are used as
homes today.
The Chinese government’s plan to demolish underground
housing brings a number of issues to the forefront. For
one, how did these underground spaces become such
a significant part of Beijing’s capital city? How will the
government address the economic and humanitarian
challenges of evicting a population of 1 million
underground urban migrants? How will the plan be put into
effect and over what time frame? And, in a crowded city
with expensive housing, how should the spaces be used in
the future?
An Integral Part of the City
While many developing cities have faced acute housing
issues – from the slums in Leeds in 19th century England
to the favelas in Rio de Janeiro — Beijing faces a unique
confluence of factors. An unprecedented pace of
urbanization, outdated government policies and the city’s
reputation as a land of opportunity all led to the flourishing
of below-ground communities.
First, Beijing has seen one of the fastest urbanization
periods in history. Professor Li, who teaches at a prestigious
university in Beijing and did not want his full name used
because of the sensitive nature of the topic, conducts
research that supports the local government in urban
planning. He notes that since the 2008 Olympics in Beijing,
58
the city’s population has been increasing by about 500,000
per year. Even though half of Beijing’s current housing was
built in the last 10 years, it has not kept pace with demand.
Second, government policies have both exacerbated
the challenge of finding housing and helped establish
the underground spaces that are used as homes today.
China still maintains a household registration system — a
carryover from central planning policies — in which, despite
some recent loosening of controls, migrants from outside
of Beijing cannot buy houses or benefit from government
housing support.
This led to the rise of informal housing options, including
the practice of crowding multiple people into apartments
— or crammed renting — as well as underground living.
In Beijing, the per capita living space among migrants
can be as small as 60 square feet, compared with 210
square feet for native residents. In addition, the fear of
potential attacks from the Soviet Union during the 1960s
and 1970s led the Chinese government to mandate that
housing developments in major cities including Beijing
have underground spaces with minimal plumbing that
could be used as temporary bomb shelters. This resulted in
thousands of previously underutilized spaces two or more
stories underground. However, these underground spaces
were not designed as permanent residences.
Finally, Beijing is still recognized as a city of opportunity
and especially welcoming to migrants. Huo speaks of
people starting anew and becoming rich, similar to the
“American dream.” This reputation draws people from
different social strata to the city despite its shortcomings.
A 2014 study by Kim estimated that approximately 1
million migrant workers live in underground apartments,
and Li’s own research shows that these residents come
from different levels of society, including builders, teachers,
beauticians and nurses. The large population, varied
economic functions and levels of social standards reveal the
deep level of integration of the underground society with
the rest of Beijing.
Changing Policies
The underground housing situation is in a state of flux and
will likely look very different a decade from now. Spurred
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
by challenges involving the health and safety of current
residents, as well as its vision for Beijing’s future role in
China’s northeast, the central government has begun to
implement policies to eliminate underground housing and
develop the manufacturing industry in nearby regions,
creating a potential solution for migrant workers in Beijing.
According to Li, while fire and flooding have always been
hazards, it was not until several deaths occurred that
Beijing’s government began to roll out policies aimed at
closing the underground housing. Those deaths, which
were well publicized by the press, came about after a flood
and poorly installed electric cables led to the electrocution
of two people in 2012.
A concurrent safety concern is the long-term effect
of pollution. Beijing’s rapid urbanization has led to an
unprecedented number of cars on the road. The sheer
number of vehicles, along with the still-present factories
in Beijing, accounts for most of the air pollution that
continues to attract intense media coverage and global
criticism. Policies aimed at reducing the population
pressures of top-tier cities such as Beijing are thus related
to the wide-ranging government efforts to address
pollution in China.
Another key driver for the government’s removal of
underground housing is the desire to transform Beijing
into a more service-oriented economy, which plays a role
in the development of a new, integrated urban area called
‘Jing-Jin-Ji’ (from Bei‘Jing,’ Tian‘Jin’ and ‘Ji,’ the ancient
name of Hebei province). Li describes this plan as reducing
duplicative industries in the region by moving existing
manufacturing businesses, such as garment manufacturing,
steel production and ocean logistics, to Tianjin and the
Hebei province, which can help transition a large segment
of lower-waged migrant workers out of Beijing while
evolving the city’s tertiary industry.
As a result of safety concerns and its longer-term economic
vision, the government has rolled out policies to eliminate
underground housing in the next three years. Li takes a
more realistic view, noting it may take several more years
to initiate. While the government directly owns some
underground spaces, other spaces were granted 5- to 10year contracts prior to 2010. The government will likely
Growth Strategies in a Global Economy
need to wait for the contracts to end and then take over
and repurpose the underground properties.
New Opportunities
Relocating more than a million people is bound to be
a monumental task that will face challenges as well as
opportunities along the way. Eviction of the underground
residents can be viewed from two angles: How would
the underground spaces be reused, and where will the
residents go?
Providing alternative housing
solutions for migrants is a tougher
challenge, especially given the
government’s goal of slowing intense
population growth.
Li and many residents, including Huo, believe that
transforming the spaces into underground car parks is the
best solution. These facilities, which do not require the
same level of air quality and lighting as residents, would
alleviate the parking shortage problem while earning ticket
revenues. Moreover, some are already being converted into
luxury retail areas, such as underground cafes, malls and
swimming pools. Li believes the government might have
underestimated the economic value of these underground
spaces and their use as private development operated
by real estate businesses, or as gyms, cultural centers,
libraries, community open spaces and others.
Providing alternative housing solutions for migrants is
a tougher challenge, especially given the government’s
goal of slowing intense population growth. The longterm transition to an integrated economic zone across
Hebei, Tianjin and Beijing will provide dedicated housing
opportunities for people in the manufacturing industry
outside Beijing, but there will still be short-term pressures
as well as a significant service-oriented population that
will seek to remain in the city center and support the city’s
economy.
59
Li observes both formal and informal options to evict
residents of underground housing. Informally, some
residents will find housing on the outskirts of Beijing’s 5thand 6th-ring roads, which already cover a huge geographic
area. In order to stay centrally located, however, many
residents are turning to crammed renting in apartments
located near the 2nd- and 3rd-ring subway lines and fit
more than eight people to a room — violating the legal
requirement of 86 square feet per person. The scale of
this housing option is significant and increasing: Crammed
renting listings can be found easily online and via telephone
hotlines.
A more formal near-term solution that Li believes will
align with Beijing’s development objectives is to repurpose
factories and unused spaces in the city center into cheap,
government-subsidized housing. This will accelerate the
migration of industry to the industrial hubs in Tianjin and
Hebei while immediately solving some of the more pressing
housing needs in Beijing. This type of housing is provided
today, but the supply is still too limited because much of it
was offered exclusively to government employees. Now
it is being opened up to migrants who do not hold Beijing
resident permits.
However, Li still thinks the current population in Beijing
requires tight controls to prevent exacerbation of housingsupply issues. Thus, it is highly unlikely that the government
will significantly loosen the system restrictions in Beijing.
However, it has taken some steps by issuing transitional
resident cards based on criteria such as employment,
length of stay and educational level — much like the greencard system in the U.S. In the long term, once the pace
of urbanization stabilizes, Li thinks the system can be
standardized and opened up across cities as has been done
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in other Chinese cities such as Chongqing, which doesn’t
face the same demand and supply constraints.
Performing on a Global Stage
The 2008 Olympics put Beijing in the global spotlight.
Under the glare of the international media, the city
carried out many temporary policies — including removing
unsanitary street vendors and clearing out huge numbers
of migrant workers who had constructed most of the
Olympic sites — to present the image of a clean, global
city. This kind of internationally reactive behavior was also
reflected in the original decision to build the underground
spaces to address a potential Soviet conflict.
Another motivation behind the recent policies to evict
underground residents could also be political in nature,
driven by the need to build and maintain Beijing’s
reputation as a global city. This point of view may provide
insight into the nature and timing of future policy changes,
such as easing transport pressure with underground
car parks, developing global-standard luxury amenities
underground or implementing key policies in advance of
the 2022 winter Olympics, which is slated for Beijing.
Whether it is about adjusting historical urban planning
policies to meet tomorrow’s demands, accelerating the
move from central planning to a more fluid and competitive
labor market or proactively adjusting the image of a
city in the global spotlight, the case of the underground
residents highlights Beijing’s unique challenges as well as
opportunities for innovative urban solutions to be found in
a continuously evolving China.
This article was written by Dee Ng, Joshua Lee Van Dyke and
John Withers, members of the Lauder Class of 2017.
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
WHEN CULTURE CLASHES WITH PROGRESS
Why the Organic Food Industry in China Hasn’t
Taken off
With a burgeoning middle class willing to spend more money for high-quality food, China is ripe
for a meteoric rise in the organics industry. But the numbers tell a different story.
China’s rapid growth over the past few decades has dazzled
the world. Until 2015, it was the world’s fastest-growing
major economy and currently trails only the United States
in the number of billionaires produced. It plays a vital role
as one of the world’s leading importers and exporters, and
a sizable young population comprises its emerging middle
class. This consumer market is particularly attractive to
investors and businesses.
Favoring short-term growth, however, comes at a price.
Food safety is a systemic challenge in China and a prime
concern among its citizens. In order to compete for more
customers, who now have more money in their pockets,
Chinese food businesses have resorted to unscrupulous
methods of cost cutting. Examples covered in the media
include tainted baby-formula, cooking oil made from
waste, contaminated meat and fake eggs. People generally
mistrust the sources and third-party preparation of their
food, and news reports of food-safety scandals are fairly
common.
Given the abundance and frequency of these scandals, as
well as the increase in average income, it is surprising that
China has not seen a boom in the organics industry, which
Growth Strategies in a Global Economy
is one way to obtain cleaner, safer food. This industry is still
emerging, and only a small percentage of the population
understands what it is or consumes its products.
In general, Chinese consumers
prefer to buy imported products,
even if not organic, over domestic
organic products.
The Rise of the Organic Food Sector
The Chinese organics industry has been growing steadily
over the past 20 years, spurred by the numerous foodsafety scandals and the increased purchasing power of
the middle class. In 2013, nearly 10,000 enterprises held
organic-product certificates. In terms of product variety,
there were 1.6 billion organic labels, with total domestic
sales ranging from ¥21 billion to ¥31 billion (US$3.23 to
US$4.84 billion). Yet the numbers account for a very small
percentage of total consumption.
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Organic produce enterprises are found all over China, but
the vast majority cultivate and process their products in
less developed areas where large tracts of agricultural land
and manual labor are available at lower costs. Only 1% (3.52
million hectares) of China’s agriculture land is organic, with
most of that dedicated to farming cereal grains, fruits, nuts
and vegetables for domestic and international consumption.
A small portion is reserved for organically raising livestock,
poultry and aquatic products. Historically, most of the output
has been exported (sales of ¥160 million or US$25 million)
to countries including the U.S., Germany, the Netherlands,
Canada and Japan, with sales increasing annually. The U.S.
is this industry’s largest export partner in terms of sales and
volume and buys primarily agricultural products.
The Chinese government is more
concerned about food security for
its population of 1.4 billion than
about promoting organic products.
Along with the rise in organic-product exports, domestic
demand has also increased significantly. Chinese consumers
have become more health-, safety- and environmentally savvy
and are willing to pay a premium price to purchase organic
goods. Often, the price for organic products is double to
quintuple that for conventional products. Given these higher
prices, it is no surprise that most of the organics industry’s
consumers live in urban and wealthier cities, otherwise
known as China’s “first-tier cities,” such as Beijing, Shanghai,
Guangzhou and Shenzhen. The majority skew younger (2040 years old), are professionals (e.g., teachers, white-collar
workers and civil servants) and possess high education levels.
They work in occupations that provide sufficient disposable
income to buy organics or are in the position to give gift
baskets made up of luxury organic goods.
Because of China’s large market of consumers and an
increasing demand for organics, 51 foreign firms have
entered the market to compete and/or partner with Chinese
retailers. Through high-end supermarkets, organic specialty
stores or online shops, these companies sell primarily
gourmet dairy, wine, infant food, olive oil and grain products.
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Challenges for the Organics Market
Despite the clear growth in China in recent years, the
organics market still faces a number of challenges in the areas
of consumer confidence, logistical distribution, support and
government policy.
Youting Zhang of Organics and Beyond, an organic retailer in
Beijing, said consumer trust is the greatest challenge to the
growth of the organic market in China. Because of intentional
mislabeling of products as “organic” and the prevalence of
fake goods on the market, consumers are more skeptical.
They are less willing to pay a premium price for organic
fruits and vegetables they fear are fake. This skepticism
and distrust have forced organic-food producers to mark
their products as “regular” versus “organic” to avoid excess
amounts of inventory. In 2013, of the ¥80 billion (US$12.5
billion) in organic products produced in China, only ¥25
billion (US$3.9 million) were sold as such. This is problematic
because it puts pressure on organic food companies’ profit
margins and is detrimental to the entire industry’s growth.
On sites such as Taobao, an eBay-style online marketplace for
private buyers and sellers, there is a lack of trust regarding
the legitimacy of organic-labeled products. Customers
are reluctant to purchase these goods without verified
information, particularly in the aftermath of the slew of foodsafety scandals. Unethical practices on the part of retailers
who intentionally mislabel products dampen both domestic
and international demand for Chinese organic products.
Foreign importers are loath to take the risk. According to
the U.S. Department of Agriculture’s Global Agricultural
Information Network, many American grocery chains have
stopped carrying certain products from China labeled as
organic.
Because of the Chinese population’s distrust of domestic
organic labels, competition has emerged in the form of daigou,
a method of paying either a family member or other Chinese
national living or traveling abroad to purchase goods in bulk
to bring home. It has become one of the main channels for
Chinese consumers to buy high-end goods at substantial
savings (e.g., luxury handbags generally priced 30% higher
in mainland China) and also avoid perceived quality gaps. In
general, Chinese consumers prefer to buy imported products,
even if not organic, over domestic organic products. Thus,
daigou poses a significant challenge to local retailers in the
Chinese market.
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With the existing demand, organic retailers are facing
challenges with distribution and delivery. One new
sales channel that has seen significant growth despite
still comprising a small percentage of the market is
e-commerce. Online retailers such as Yihaodian, Tmall
and Taobao are offering fresh organic produce online for
delivery. Their challenge, however, lies in the relatively high
logistical costs and spoilage rates on the road to delivery.
According to the Organic Trade Association’s market
report, Yihaodian — 51% of which is owned by Wal-Mart
— is setting up a proprietary last-mile delivery system.
Another player, Shunfeng First Choice, which belongs to
delivery company Shunfeng Express, delivers products to
customers directly from the farms, offering a more efficient
and cost-effective system.
On the policy front, Zhang noted that a challenge for
Chinese companies exporting products or foreign
companies entering the Chinese organic market is the lack
of multilateral recognition of certification requirements.
The Food and Drug Administration in the U.S. does not
recognize Chinese organic labels, and vice versa. Any
foreign company or product entering either market must
go through independent Chinese certification processes.
As expected, these processes can be costly, lengthy and
complicated (multiparty), which deters foreign firms
from entering China. According to a 2011 report by the
International Trade Centre, the Chinese government is in
negotiations with the European Union, the U.S., Canada,
Japan, Australia and Thailand regarding regulatory
recognition. It is unclear when or if these negotiations will
result in any international cooperation.
According to Bugang Wu, a specialist at the U.S.
Agricultural Trade Office in Beijing, the Chinese
government is more concerned about food security for
its population of 1.4 billion than about promoting organic
products. Wang Shiyan, the Chinese vice-minister of land
and resources, stated that 3.3 million hectares of land,
about the size of Belgium, are too polluted to farm as a
result of increasing pollution and urbanization policies.
There are a limited number of farms that can be converted
from conventional to organic, preserving valuable arable
land for high-quantity-production farming techniques.
Farmers are not incentivized to convert, partly because of
the low demand for organic products and partly because
Growth Strategies in a Global Economy
conversion processes for farms are lengthy, taking up to
three years to complete. Farmers who choose to convert
must pass through several harvests to rid the soil of
pesticides and chemical components. By law, even planting
in previously uncultivated earth requires one year of soil
purification. While the actual certification process is only a
few months, many farmers cannot afford the years of lost
income. The production of organic goods has been and will
be limited because of this lack of dedicated soil.
Because of the many challenges
facing the Chinese organics industry,
projections for its future growth are
modest.
Opportunities and the Future
Because of the many challenges facing the Chinese
organics industry, projections for its future growth are
modest. By 2020, only another estimated 0.25% to 0.55%
of the country’s arable land will be converted to organic
agricultural production, bringing the total organic land
percentage to between 1.2% and 1.5%. Market share of
organic foods is forecast to reach only 1% to 3% of China’s
total food consumption, compared with the U.S., where
similar sales already accounted for 5% of the market
in 2014. China’s organic-product exports in 2020 are
expected to comprise only 1% to 1.5% of the global total.
The modest growth forecasts for the Chinese organics
industry illustrate the obstacles companies face there.
However, those that can overcome the impediments have
a significant business opportunity. With the high barrier
to entry and a low competitive landscape, organic food
companies that are successful can capture a large share of
the industry and the vast majority of its overall growth. A
prime example of such a company is Organic and Beyond.
Established in 2007, it is a Chinese online distributor of
home-delivered organic foods. Its product offerings range
from produce and seafood to processed foods, such as
chocolates and special-occasion Chinese mooncakes. The
company uses a subscription-based model and distributes
to over 200,000 families across six of China’s major cities.
Although still young, it reported annual revenues of ¥200
63
million (US$30 million) in 2012. It is currently planning to
expand beyond online distribution to provide on-demand
organic meals targeted at urban office workers.
Several factors have helped Organic and Beyond deal with
many of the challenges common in the Chinese organics
industry. The company benefits not only from a firstmover’s advantage but also from a network of organic food
and agriculture experts and an “all-in” business model that
supports organic-food initiatives outside its core business.
This leads to name recognition in the industry and helps win
government-approved contracts and certifications.
When Organic and Beyond was founded, there were fewer
than 2,400 organic food products available in China. Hence,
this company was one of the first in the country to own
organic agricultural land and to offer home delivery of
organic foods. Its founder, Xiangdong Zhang, has focused
his business on building trust in the brand among Chinese
consumers. To achieve this goal, he employs a team of
industry experts, including Youting Zhang, who holds a
master’s degree in organics, and Jianwei Zhang, who holds
a Ph.D. from China Agricultural University. The company
is also supported by an advisory group of academics and
professors in agricultural fields. Cited in many consumerfacing marketing materials, this network of experts
builds consumer trust by elevating Organic and Beyond’s
legitimacy.
Further enhancing its image, the company participates
in activities outside the home-delivery arena. It
hosts consumer visits to its organic farms and offers
informational sessions at local companies in order to
educate young professionals. It also publishes numerous
reports on the organics industry and participates in many
industry conferences and forums each year. By establishing
itself as a leader in the industry, its “all-in” business model
raises consumer awareness and trust.
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Organic and Beyond’s network and name recognition have
another major advantage: It is successfully leveraging
these aspects to win joint-venture contracts with foreign
suppliers. In addition to the academic experts, its advisory
group includes members from state departments and
government committees. In a relationship-driven country
such as China, these government ties undoubtedly help
Organic and Beyond not only to certify its own products but
also to import products from abroad. Crabs from Alaska,
chocolates from Switzerland and beef from Australia are
just some of the examples of the organic or free-range
items the company offers. Many of the package labels for
these products feature both the original retailer’s brand
and the Organic and Beyond name. For example, the Swiss
chocolate line it offers, Cavell, is stamped with the logos
of both companies. For foreign companies, a joint-venture
with Organic and Beyond provides access to the Chinese
market with few of the bureaucratic and administrative
hassles of obtaining government certifications. For Organic
and Beyond, the joint ventures enable the company to
maintain control of and market power in the Chinese
sector.
It is very difficult for organic food companies without a
track record to enter China’s market. The challenges of
the industry are clear. The industry is small, and issues in
consumer trust, distribution, sales and government policy
result in subdued forecasts for future growth. However,
the strong barriers to entry also give market power
to firms that succeed in the sector. For the handful of
companies that can understand both the Chinese consumer
well enough to build the right brand and form the right
relationships with industry influencers, the organics sector
is an ample business opportunity and is one of the ways to
enjoy the fruits of the Chinese market.
This article was written by Maggie Diehl, Yue Li and Emily Tung,
members of the Lauder Class of 2017.
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
The Social, Political and Economic Impact of
Chai in India
Chai, a beverage with a popularity that has spread far beyond its home base of India, is steeped
in the psyche of the subcontinent. But with trendy coffee shops drawing more affluent, younger
Indian citizens, will chai become a poor man’s refreshment?
During the 2014 election, the Indian people had two
distinct choices from a class perspective. The Congress
Party’s Rahul Gandhi, representing the old guard and
India’s elite political class, hoped to extend his family’s
dynastic political dominance to a fourth generation. And
the Bharatiya Janata Party’s Narendra Modi, sensing a shift
in the nation’s psyche toward sympathy with the lower-and
middle-class frustrations, wisely presented himself as an
aam admi, or common man, in sharp contrast with Gandhi’s
privileged background. Modi’s tool of choice to craft his
aam-admi identity before the Indian people, which arguably
shaped the result of the largest election ever held in the
country, was chai.
Modi used his humble beginnings of vending chai, or Indian
spiced tea, at train stations to cement his proletarian image.
Indeed, chai, one of the most popular beverages consumed
across India, has come to symbolize the common man.
Not only does it occupy a very real and significant space in
people’s daily lives, but it has also woven its way into India’s
social fabric.
Chai’s Many Meanings
To illustrate, consider the following scenarios in which
chai plays a prominent role with varying degrees of social
significance. A boy, Kushal, and a girl, Mamta, along with
their families, are meeting for the first time in a formal and
arranged setting; marriage is on everyone’s mind. Perhaps
this meeting has been set up by a chacha (uncle) or a
meddling aunt. Or the couple may have decided to cement
their relationship with their parents’ blessings. Regardless,
the significance of this encounter is huge. It could mean the
marriage of not just two individuals but also two families
for the rest of time.
If Mamta welcomes the guests with a good cup of tea, all
is well. She has passed the first of many tests. If the chai
is subpar, however, no matter what happens next, the
Growth Strategies in a Global Economy
encounter will be colored by the taste of the disappointing
beverage. Without chai, such occasions would be
incomplete. In this situation it serves as both a social test
and a social lubricant. It signals to the drinker that the
maker is well-versed in the art and likely will be equally
adept in fulfilling the other responsibilities in marriage.
Many destinies are written in this one cup.
Imagine that Mamta’s proper cup of tea leads to a
successful wedding arrangement. She now goes shopping
for her wedding trousseau. The moment a shopkeeper
discovers she is bridal shopping, she and her companions
will be ushered into a special section of the store for, well,
special treatment. Once she begins to look at lehengas (a
type of outfit consisting of a skirt, blouse and scarf) and
tries them on, the shopkeeper will begin to gauge her taste.
Not only does chai occupy a very
real and significant space in people’s
daily lives, but it has also woven its
way into India’s social fabric.
As the bride likes one outfit and rejects another, her
budget will become clear to seasoned shopkeepers. If
she is deemed serious enough, she and her party will be
asked the big question, “Will you have chai?” Here the
chai is an investment in creating a deeper relationship.
If the customer has invested in the shopping experience,
shopkeepers likewise invest in the customer by offering a
cup of tea, knowing she will stay at the very least until she
has finished drinking it. This not only buys the shopkeeper
time to show customers more items but also to make them
feel indebted — that leaving without making a purchase
would now be awkward at best and rude at worst. Chai is a
65
symbol of the shopkeepers’ investment in the customer and
invokes reciprocity.
Yet another example of chai in a social setting, and perhaps
the most common, is during work breaks. Employees can
drink it at their desks or at a stall. They can have it alone
or use the time to gossip and catch up. The tea break and
tea stall serve as the equivalent to the water cooler of the
American work culture, while providing a beverage that
is more flavorful and energizing. In this scenario, chai is a
reprieve and a chance to refresh oneself before the midday
meal or before heading home. It’s a promise that life will be
better in that moment the beverage is consumed, even if it
isn’t otherwise.
Chai is a reprieve and a chance to
refresh oneself before the midday
meal or before heading home. It’s
a promise that life will be better
in that moment the beverage is
consumed, even if it isn’t otherwise.
Chai’s Introduction to India
With its tantalizing aroma, delicious flavor and symbolic
place in society, chai has become — and likely will continue
to be — a central part of the Indian psyche. The pervasive
habit of tea drinking in India, characterized by the frequent
daily consumption of small cups of the milky and cloyingly
sweet beverage augmented with ginger or cardamom, has
promulgated the misconception that tea has had been
around on the subcontinent for a long time. To understand its
origin in India, one must first know that it was not introduced
to the subcontinent until the period of British rule.
Acquired in the late 17th century from the Dutch and
Portuguese, the upper-class British custom of tea drinking
gradually trickled down to the lower classes and became
a national habit within a century. This growth in the
consumption of tea was partly facilitated by the gradual
decline in the price of tea due to heavy imports from China.
The East India Company, which had already begun to wield
its hegemonic influence over India by the middle of the
18th century, dominated the trade of tea. The company
66
would pay for Chinese tea using opium that was grown in
northeast India. Despite these arrangements, the British
could not but help feel nervous about the perceived
monopoly that China seemed to enjoy over the production
of the company’s most prized commodity and the daily
beverage that had now become such a part and parcel of
being British.
Some East India Company officials soon realized that the
tea plant Camellia sinensis could be cultivated in Britishcontrolled India and began experiments with smuggled
plants around 1774, albeit in vain. In 1823, growing on
the forested hills of Assam, a plant reminiscent of tea was
found and christened the Camellia assamica. Soon after, the
company sent a consignment of a handful of chests of this
tea and put them up for sale in London in 1839. The auction
led to a tea rush. The next half century saw acres of forest
being replaced with millions of seedlings of this new tea
plant. By 1888, the amount of tea exported from India to
the United Kingdom surpassed exports from China. By the
20th century, tea from China was eventually priced out of
the U.K market.
The tea produced in India was primarily exported to the
West, although a small portion of the production was
auctioned off in the markets of Calcutta to a small native
community that consisted of the Anglophile elite and babus
who worked for British firms and were slowly developing a
taste for this ‘foreign’ beverage consumed by the colonial
masters.
The tea industry was fraught with several challenges,
including unpredictable London auction prices and the
complications of long-distance transportation. These
factors prompted officials to introduce Indians to tea
and perhaps unlock a major market in the subcontinent
itself. Although the idea that what was considered a base
and uncivilized society by the British would actually be
able to enjoy such a cultured drink was initially ridiculed,
market surveys met with moderate success. The effort was
eventually deemed unfruitful in 1904, with a final verdict
that there was no conclusive evidence that India would be a
promising market for the crop.
In fact, tea growers voluntarily paid a tax to the Tea
Cess Committee (TCC), which was tasked with finding
new markets for tea. The TCC had begun organizing
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promotional activities in the United States and Australia to
uncover potential markets but had not been as successful.
The market for tea in India also remained largely elusive
as its perception remained negative, especially during the
independence struggle when tea as a “foreign” commodity
was considered to be painted with the blood of the
peasants and laborers exploited by the British colonial
regime. Long-held cultural preferences for other beverages
also played a part in keeping the popularity of tea in check.
Winning over the Indian Consumer
During the first 30 years of the 20th century, tea
advertisers primarily targeted British residents of India
and the Anglophone elite, although the TCC did make
feeble and infrequent attempts to create a demand for the
product among Indians by giving away samples of prepared
tea and selling cheap, bite-sized packets of leaf fragments
or broken tea that would provide a taste to the wider
audience. By 1930, over 90% of the crop was still exported
to the British, and only an extremely small number of the
local populace had ever tasted tea.
As a result of the Great Depression, international tea prices
dropped sharply even in the face of record production,
and by 1935 tea plantation owners found themselves with
more than 100 million pounds of unsold surplus. Finally
acknowledging the opportunity of more than nearly 350
million people at home, the TCC transformed itself into the
Indian Tea Market Expansion Board (ITMEB) and was given
a larger budget. The ITMEB then conducted an elaborate
marketing campaign following a methodology similar to
what had previously failed. A vast group of tea evangelists
were tasked to give away millions of cups of tea and sell
an equal number of “pice packets.” The campaign featured
colorful signs in local languages produced by commercial
artists and enamel placards posted in railway stations
and markets, paternalistically instructing readers about
the correct British method for preparing tea. All these
campaigns had the singular aim of trying to persuade the
average Indian to take up the habit.
While some experts claim that such tea campaigns
during the 1930s managed to win over the hearts of the
subcontinent, in 1947 over 70% of India’s tea crop was
still exported and the per capita consumption remained a
meager 0.4 pound per year. It could be argued that despite
Growth Strategies in a Global Economy
more than 50 years of sporadic efforts, an ingenious
advertising strategy and creative campaign signs, the
majority of Indians had never tried — or possibly never
even heard of — the crop or the beverage.
The newly reconstituted ITMEB, or Tea Board, persisted
with its campaign into the 1960s, using a cartoon mascot as
a spokesman. The various strategies to dispense free cups
of tea or sell “pice packets” to entice consumers gave way
to private enterprise, and the Tea Board spent its budget
primarily on efforts to increase India’s waning market share
in the global tea trade.
The economic politics of chai may be
seen as a metaphor for the cultural
politics of India itself.
What is also remarkable is the persistent effort to educate
Indian consumers in how to make tea correctly in the
“civilized” British manner. The method maximized the
amount of leaves required, thereby helping to increase tea
revenues. By contrast, the Indian technique was starkly
different and often incorporated far more milk than was
desired by British tastes. If the Indian tea drinker had
access to milk, the tendency was for water to be entirely
eliminated and milk to comprise more than half of the
beverage. The Indian preparation also encouraged the
mixing of spices, such as shredded ginger or crushed
cardamom, in line with the Indian food aesthetic of strong
aromas, colors and flavors.
The use of Scottish crush-tear-curl machines was
instrumental in driving tea prices to affordable levels and
catalyzing a massive growth in consumption by the general
Indian public. The machines, particularly the slidingblock variety designed by Indian engineers in Calcutta,
revolutionized the tea-manufacturing process in the
1960s to 1980s by allowing for “continuous manufacture,”
a practice that dramatically reduced the need for human
labor in factories. The economies of scale achieved caused
the per-unit price of prepared chai to drop sharply and
effectively doubled the “cuppage” from 250-300 to 500600 cups per kilo of dry tea. With this proletarianization of
tea consumption, the domestic market accounted for more
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than three-quarters of India’s tea crop of more than 1.8
billion pounds per year by the end of the 20th century.
The practice of drinking chai continues to evolve in modern
India. Interestingly, this evolution reflects two broader
flashpoints in the country’s culture and politics: the
question of national identity in a highly regionalized society,
and globalization and its impact on the widening gap
between the elite and the masses. The economic politics of
chai may be seen as a metaphor for the cultural politics of
India itself.
Anekta Mein Ekta: The Identities of Chai
Commonly compared to the European Union, India’s states
are akin to countries in their different cultures and, most
importantly, in their fiercely distinct identities. Since the
country attained independence in 1947, its leaders have
confronted the challenge of forging political and cultural
bonds within this colorful melee. Chai is no exception to
this rhetoric of unity. Today, the saga of chai and national
identity continues, but the current chapter revolves around
the struggle to establish national brand recognition while
also creating different blends to satisfy regional tastes.
While sharing this same goal, multinational companies
and regional players in the tea industry have opposing
capabilities: the former hold brand recognition but do not
resonate as regionally emblematic, while the latter have
loyalty within pockets but little national brand awareness.
As such, both are reorganizing and campaigning.
Multinational companies are attempting to appeal to
specific regional audiences, as seen in Hindustan Unilever
Limited’s new reorganization into “clusters” that customize
mass-market products specifically for each region.
Meanwhile, regional players are attempting to expand
nationally, with tactics such as vending machines in offices
and branded tea lounges. Both groups appear to be using
the same rhetoric employed by politicians for decades
— of anekta mein ekta, or “unity in diversity.” The saying
is exemplified in an ad by the regional Gujarati company
Wagh Bakri, which uses the slogan along with the image of
individuals from multiple states all drinking the same chai.
Such marketing only reinforces the close links between chai
and the question of regional versus national identity.
India and Bharat: Coffee, Chai and Class
While coffee itself is not a new phenomenon in India,
having been consumed for decades particularly in South
India, the entrance of Western-style coffeehouses is a
fairly recent trend. Domestic chains such as Café Coffee
Day battle with international behemoths Costa Coffee and
Starbucks for their share of the upper- and middle-class
customers now trying their menus. But interestingly, these
shops may represent a culture more than a drink. As Rajini
Vaidyanathan relates in a February 9, 2012, BBC Magazine
article, “India’s coffee culture has changed the way young
Indians socialize.” These cafes provide a socially acceptable
and attractive space for individuals to mingle, linger and
interact across genders and ethnicities, often away from
censoring parental eyes. Yet this revolution is limited by
virtue of its cost. A cup of roadside chai may be had for as
little as Rs.5 (US$0.08), compared with the flavored and
frappéd drinks of the coffeehouses, which cost Rs.100
(US$1.54) or more.
The country’s two most common names are often used
to describe its socioeconomic divide, with the Anglicized
“India” denoting the upwardly mobile and urban classes and
the Sanskrit Bharat standing for the rural and uneducated
poor. Coffee and chai arguably reflect that separation, with
many citing globalization’s impact — as represented by
coffeehouses — being limited to the elite of “India,” pulling
them socially and culturally even further from the masses
of Bharat, who outnumber the elite by far but are unable
to afford such luxury. While much ink has been expended
on analyzing the coffeehouses’ future in the supposed land
of tea, the question may not be whether coffee will shift
Indian beverage preferences at a national level but rather
what impact its social significance has accrued.
The future of chai is murkier in terms of social significance
than it is economically because the tea market as a whole
is unlikely to collapse, given its accelerating exports.
What will chai signify in the coming years? Will it remain
a national symbol or become an emblem of the working
class and the poor? Much will depend on tea companies’
responses to these new developments among the young
and the success of their rebranding attempts.
This article was written by Neha Goel, Manu Mohan, Nidhi
Shah and Aroon Vijaykar, members of the Lauder Class of 2017.
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Knowledge@Wharton • The Lauder Global Business Insight Report 2016
Entrepreneurship and the Custo Brasil
A plethora of great enterprise ideas are generated in Brazil, but many rarely see the light of day
because of what is known as the custo Brasil — or the cost of doing business.
While economic opportunities in Brazil are plentiful, the
reality of being an entrepreneur is difficult due to the
country’s poor infrastructure, lack of funding, complex
bureaucracy and limited talent pool. These challenges
comprise what the Brazilian media and business community
call the custo Brasil, or the cost of doing business in Brazil.
Those who have the patience and resilience to ride the
rising but bumpy road of Brazilian growth may be able
to capitalize on the huge opportunity, but they must first
overcome these major obstacles.
With a population of over 200 million and a gross domestic
product of over R5.5 trillion (US$2.4 trillion) as of 2014,
Brazil is one of the world’s largest economies. This
represents a huge opportunity for Brazilian entrepreneurs
to take advantage of untapped markets, a large consumer
base and a dynamic economy.
The Brazilian tech sector is a great example of the
scope of the opportunity. Despite the lack of a robust
telecommunications infrastructure, Internet penetration
is 50% and growing rapidly, and it serves as a strong
foundation for Internet-based startups. Likewise, credit
card penetration, a key driver of digital commerce, is
69%. The United States has similar penetration (81%
Internet and 71% credit card) but with exponentially more
entrepreneurs and established companies competing to
provide services through these channels.
Relatively speaking, Brazil also has a high penetration
of mobile phones and smartphones, with an average of
2.4 SIM cards per capita and a penetration of 23% for
smartphones. As Alejandro Vázquez of Nuvem Shop, an
e-commerce platform, explains, “Smartphone penetration
is really high in Brazil. There is a huge opportunity in mobile
business of all kinds.”
In addition to growing underlying drivers, Brazil also has a
large consumer base, much of which is young and open to
technology. For example, the country’s wealthiest “Class
A and Class B” have approximately 70 million people,
Growth Strategies in a Global Economy
greater than the entire population of Canada. Brazilians
tend to embrace technology, especially because 34% of the
population is between the ages of 20 and 40, compared
with 27% in the U.S. Brazil ranks high in web and socialmedia usage, with Facebook penetration at 35%, compared
with 5% in India.
From overcrowded roads and ports
to antiquated and wasteful networks
of water and electricity distribution,
Brazil is infamous for its insufficient
infrastructure.
Innovation and the Global Outlook
Despite the many opportunities, real innovation in Brazil
has been limited. Until now, entrepreneurship has been
dominated by copycat startups that replicate proven
models from more developed markets. Vázquez notes,
“There is almost no real innovation coming out of Brazil. It’s
hard to get funding here for ideas not already validated in
the U.S. or Europe.”
Copycats do not always work, especially when the
company fails to adapt the business model to meet the
needs of its Brazilian customers. “It’s important to learn
from existing models, but not copy them directly,” Vázquez
said. “You have to think about your customers in Brazil
and the problems in Brazil…. That’s the hardest challenge:
understanding what you have to copy and what you have to
do differently.”
Even when true innovation occurs, many Brazilian startups
look abroad to expand their business. For some founders,
Brazil is a place to start and to identify a unique solution
before finding customers abroad who see the value of their
product. This trend may be influenced by the sophistication
69
of customers abroad, the economic conditions in Brazil or
other factors.
This is what is happening at BovControl, a promising
startup that leverages existing implant technology to
provide farmers with data on their cattle through an app. Its
founders are increasing their focus on the U.S. and Chinese
markets because of the higher quality of established
bovine-tracking technology, cattle farmers’ readiness to
use new technology and the greater opportunities in those
markets. As Danilo Leão, CEO and founder, explains, “Our
main goal in the short term is to have relevance in the
U.S. and then move to Asia. China is having big problems
with traceability. One retailer had a huge problem, which
led to a loss of $1.5 billion worth of beef.” As one of the
world’s largest exporters of beef, Brazil is still the primary
market for BovControl, but the company has other markets
competing for its attention.
Many Brazilian employees see large
and stable companies as a safer bet
and are not swayed by the exciting
environments typically associated
with startups in the U.S.
In some cases, the global outlook is at the peril of Brazilian
interests. At SensorBox, an Espirito Santo-based startup
that builds and sells telemetric monitoring equipment for
large telecom companies and commercial and residential
buildings, the founders are shifting their focus to Europe
and America. There, clients are more willing to invest in
technology that can reduce energy costs significantly. In
Brazil, companies are accustomed to broken infrastructure,
and high electricity costs are the status quo. A product
that could monitor energy usage and potentially reduce
costs is perceived as an incremental investment. This is
exacerbated by difficult economic conditions in Brazil,
making technology investments even tougher to execute.
The Problem of Poor Infrastructure
From overcrowded roads and ports to antiquated and
wasteful networks of water and electricity distribution,
70
Brazil is infamous for its insufficient infrastructure. Despite
substantial web and mobile penetration, the dearth of
reliable Internet and telecom infrastructure limits the
number of consumers that Internet and mobile-based
startups can reach. Even in metropolitan cities such as
São Paulo, startups cannot rely on consistent Internet
connections even in their own offices, which impacts
productivity and the functionality of their sites and apps.
Brazil also suffers from transportation-related
infrastructure issues that impair logistics and shipping.
These problems limit growth in e-commerce, the
most significant industry within the sphere of tech
entrepreneurship. In many cases, Brazilian carriers are
unable to conduct timely and cost-efficient deliveries. This
results in a much higher rate of late or damaged deliveries,
or packages that are lost altogether. As Vázquez explains,
“Shipping and logistics is a great issue, especially for
e-commerce. Right now, Correios is the only carrier that
reaches the whole country, and it’s very inconsistent.”
Virtual infrastructure, including the financial and
educational systems, is also impacted in Brazil. Opening
bank accounts and moving money internationally is
difficult, especially for entrepreneurs who receive
investment funds. “The financial system infrastructure
is a complete joke,” Vazquez said. “Everything is difficult
when it comes to banking and moving money around
internationally for a business. Fraud is also a huge problem
for online businesses.”
Limited Funding Hampers Growth
Brazilian venture capital is nascent and still has a limited
number of players devoted to the region. Angel and seed
investment opportunities exist, but venture capital is quite
limited beyond that. Vázquez explained that local investors
are eager to invest seed capital in great teams with great
products because so few exist.
However, even after rounds of early funding, it is much
harder to find investors willing and able to write checks
large enough to drive significant growth. In Brazil, there
are few venture capital firms with sufficient funds to
make more than a Series A investment. Most Series B+
investments in startups come from foreign firms, but such
opportunities are limited because foreign investors are
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
often skeptical of Brazil given the complexity of doing
business there.
Entrepreneurs also have difficulty finding what is known
in the industry as “smart money,” that is, investors who can
provide expertise and guidance. Most Brazilian investors
have made their money through traditional businesses
and lack the experience required to guide tech startups.
Local investors are typically more risk-averse and generally
seek to collect returns early. They may prioritize margins
before the top line has already developed. In contrast,
Silicon Valley investors are more used to growth paths that
prioritize developing a client base at scale before collecting
returns or even monetizing the business. The Brazilian
investor’s focus on early profitability often limits the
startup’s ability to scale rapidly, if at all.
According to BovControl’s Leão, “Fundraising is an
entrepreneur’s top concern; if you want to be competitive
worldwide you need funds. Considering the limited funds
in countries like Brazil, local funding is not enough. You
can get the confidence of local investors to raise a seed
round locally, but you cannot rely on those VCs in the
longer term only. It is important to have other options
abroad, as the local market is scarce. So, it is a matter
of building relationships worldwide for future rounds of
investments.”
Nevertheless, there are some reasons to be optimistic
about funding opportunities in Brazil. Many projects, run by
either the government or private companies, aim to provide
entrepreneurs with small funding opportunities. For
example, over the past few years there have been attempts
to build the local ecosystem by creating incubators or
accelerators. These initiatives have facilitated the creation
of a number of companies, even though none are yet clear
successes.
One example is the government’s Financing Agency for
Projects & Studies (FINEP), which launched a significant
project to support startups. This project will disburse
around R255,000 (US$65,000) to startups focused on
innovation. FINEP expects to help 10,000 innovative
companies over four years, generating 10 new jobs for each
new company.
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On the private front, some pioneers are bridging the gap
between Brazilian entrepreneurs and experts abroad.
Brazil Innovators, for example, was established in 2009 to
connect Brazilian entrepreneurs with investors in Silicon
Valley. Bedy Yang, its founder, has now moved on to lead
500 Startups, an accelerator program with a focus on
Brazil and Latin America. This initiative offers four-month
programs in San Francisco and Mountain View, California,
and in Mexico City.
There is evidence that funding challenges are slowly being
addressed. Venture capitalists also see the opportunities
in Brazil and know they must have a presence there if they
want to be relevant in emerging markets. For example,
RedPoint e.Ventures, Monashees, Kaszek Ventures and
Rocket Internet are raising funds and attracting coinvestments from other emerging markets and the U.S.,
helping to boost Brazil’s profile in the world of global
venture capital.
Bureaucratic limitations affect
companies in real ways. It takes,
on average, 119 days and 13
bureaucratic procedures to start a
business in Brazil.
Stifling Bureaucracy
Bureaucracy is part of custo Brasil and hits entrepreneurs
especially hard. According to the World Bank, Brazil
ranks 126th of 183 countries in terms of ease in starting a
business, despite the country’s enormous growth over the
past decade.
Bureaucratic limitations affect companies in real ways.
It takes, on average, 119 days and 13 bureaucratic
procedures to start a business in Brazil. Construction
permits take an average 469 days and 17 procedures to
be approved. The tax system is so complex and demanding
that most businesses opt to hide cash earnings from the
government.
71
Some entrepreneurs are moving their businesses
elsewhere to avoid the Brazilian bureaucracy. For example,
after increasing interactions with American venture
capital funds, BovControl’s Leão was contacted by a
lawyer, who, along with others, persuaded him to move
half of his operations and the company’s legal entity to the
U.S. The most convincing aspect was the opportunity for
Leão to leverage Silicon Valley’s existing entrepreneurial
infrastructure. “To create the U.S. entity, it took three
weeks. It took six more months to connect the entities in
Brazil. It was terrible,” he said.
If Leão wants to leverage and close an investment quickly
in the U.S., he can finish with a piece of paper while the
momentum is there. He explains, “In Brazil, if you want to
make a new investment, you have to get signatures from
all of the old investors, discuss everything with everyone’s
lawyers, who all make money by protecting their clients
beyond what is needed and create more trouble. It’s not
collaborative if you don’t have everybody looking in the
same direction.”
Due to the country’s lack of entrepreneurial infrastructure
and its unavoidable bureaucracy, Brazil loses out on the
opportunity to profit from a company that is increasing its
user base by 9.5% each week.
SensorBox experienced Brazilian bureaucracy when
it tried to get funding for two years from the Brazilian
Development Bank’s (BNDES) fund for entrepreneurs,
which offers low-interest loans to startups and growing
businesses. Because the company’s highly engineered
product contained one imported component not made in
Brazil, it could not qualify for a loan. SensorBox’s leaders
were baffled, given that this particular component was not
manufactured by any company in Brazil.
These types of limitations were factors in SensorBox’s
ultimate decision to self-fund the entire business. Not
only was finding real funding an issue, but Carlos Sacinelli
and the other co-founders believed only they should have
the autonomy to make large-scale transformations to
the company. This proved to be the right decision. With
PetroBras and other large Brazilian companies as key
clients, SensorBox’s client base crashed in 2015 amid the
economic crisis and corruption scandals. With contracts
72
being canceled and sales opportunities disappearing,
the company decided to shift its entire direction toward
product reinvention and away from commercialization. It
anticipates that a new product that doesn’t just monitor but
helps to reduce energy usage will shake up the market once
conditions ameliorate.
Was Brazilian bureaucracy a hidden lifesaver for
Sensorbox? It’s too early to tell, but it certainly influenced
key decisions and encouraged the company to be
autonomous. On a larger scale, Brazilian bureaucracy is
limiting the entrepreneurial environment to those who
have the rare ability to self-fund.
Talent and Employment
According to Jonathan Ortsman, president of the
Public Forum Institute, in 2011 small- and medium–
size enterprises were responsible for 96% of the jobs
in Brazil and comprised 98% of all companies in the
country. “We can see the increase of attendance at the
Global Entrepreneurship week from 1.5 million people
in 2008 to 5.3 million in 2009 as a huge sign of the rise of
entrepreneurship,” he said.
Indeed, in a country where about 34% of the population is
between 20 and 40 years of age, the rise is expected. But
the difficulties in funding and navigating the bureaucratic
maze limit the entrepreneurial mindset in Brazil. As a result,
strong entrepreneurial talent is lacking, especially when
compared to what is available in the U.S. Highly successful
American entrepreneurs such as Bill Gates, Steve Jobs,
Mark Zuckerberg and Jack Dorsey are cited as models
in the U.S. Apart from Mike Krieger, the Brazilian-born
cofounder of Instagram, and a handful of others, Brazil still
lacks major success stories. It is harder, therefore, for a
young generation to find a national “hero” with whom it can
identify.
The lack of an entrepreneurial mindset can be traced back,
in part, to a lack of entrepreneurship-focused education.
According to Sensorbox’s Sacinelli, the lack of such
academic programs contributes to the “recalcitrant” and
“hidden” entrepreneurial profile, which he finds common
in Brazil. For him, this is a stark contrast to the American
startup environment, which is open, courageous and ready
to take risks.
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
For those who overcome the inadequate infrastructure,
lack of funding and complex bureaucracy, talent
recruitment is the next challenge. Many Brazilian
employees see large and stable companies as a safer
bet and are not swayed by the exciting environments
typically associated with startups in the U.S. In particular,
entrepreneurs find it harder to attract good talent without
strong funding, as most potential employees prefer salaries
over equity. According to Rafael Souza Da Silva, of The Next
Player, a startup creating a platform for young athletes
to sign up and receive crowdfunding to attend trials for
professional football teams, “it is extremely difficult to
find resources because Brazilians prefer to work for great
companies, even if the situation is slowly changing.”
BovControl’s Leão adds, “High–impact, fast-growing
companies need people [who] can understand a
compensation model with equity. In Brazil, the employees
are looking for a salary, not equity, which is very hard to
pay as an entrepreneur. Corporations like Microsoft will
win over talented candidates, who are more interested in
short-term benefits. That’s part of the culture here that’s
very hard to change, and that’s why we are looking for
people outside of Brazil. We opened two positions in the
U.S., received lots of CVs, good qualification[s] and good
people, just hired one person who will volunteer for one
month. She’s so excited that she’s leaving her other startup,
will receive less in the short-term and offered to volunteer
in the first month. That kind of thing in Brazil will never
happen.”
value. Health insurance, meals, transportation and
contributions to social security increase the cost of an
employee and thus discourage hiring. A vicious cycle begins
in which management feels compelled to ask more of its
employees, who in turn feel less motivated to work for
the startup, given they could earn more and work less in
a larger structure. French entrepreneurs, who deal with
similar labor laws, have generally addressed this challenge
by hiring interns for periods of three to six months.
Unfortunately, this cannot be applied in Brazil, where
interns can work only six hours a day.
Looking Toward the Future
The opportunities in Brazil are enormous. A large
population embracing new technologies and the high
penetration of web and Internet-based channels open
significant possibilities for innovation. Indeed, within the
most promising agricultural sector in the world, a company
such as BovControl could help reinvent the way cattle
farmers produce and distribute their products. SensorBox
could help revolutionize the way energy is monitored.
The Next Player could help children in rural areas start
professional sports careers. These companies and
entrepreneurs represent Brazil’s “belief bubble,” a space
that is hard to get into but extremely promising once inside.
There are significant barriers, however, limiting the
potential for entrepreneurs to start, scale and profit from
their businesses in Brazil and, as SensorBox’s Sacinelli puts
it, “the problems are real.”
A relatively slower working culture contributes to the
challenge. SensorBox’s Sacinelli explains, “In the U.S.,
people will work 20 hours per day to get things done and
help the company outside of their regular responsibilities.
In Brazil, you can find people like this, but the obstacles
are bigger. For example, it’s difficult to find partners and
providers that understand what a startup is, and how
helping in this phase of maturity can turn a good idea into a
million-dollar business.”
Successful entrepreneurs will be able to realize the
market opportunity if they are able to overcome these
challenges. Those who can navigate the complexities of the
entrepreneurial environment will have a strong advantage
in a space where domestic and foreign competition is
relatively limited. While the fundamentals are strong and
entrepreneurship is a very promising area for Brazil, much
patience and passion will be needed to achieve success.
Finally, Brazilian labor laws are generally disadvantageous
to employers, making it difficult to fire someone and
requiring high wages that may not be in line with market
This article was written by Xavier Argente, Claudel Kamgang,
Jay T. Lanners, Jr., and Yann Manibog, members of the Lauder
Class of 2017.
Growth Strategies in a Global Economy
73
A Nation Apart: The Development of Private Equity
in Japan
While Japan has long been a global economic powerhouse, private equity investment in the
country accounts for a fraction of its transactions. The reasons are rooted in Japan’s rich
cultural heritage and more recent financial troubles. But attitudes are changing, and Westernstyle private equity is beginning to bloom.
Private equity investment has been a mainstay of the
American economy since the end of World War II. The junkbond boom of the 1980s and the dot-com bubble of the
late 1990s fueled an industry that is often characterized
by the media as ruthless and predatory. American private
equity firms are well capitalized and regularly execute
transactions in the tens of billions of dollars.
The Japanese have long placed
the needs of other company
stakeholders above returns to
shareholders.
The private equity industry in Japan, in contrast, is still in its
infancy. Its first dedicated fund was formed in 1997. Today,
industry activity continues to trail behind that found in
other economies in terms of transaction size, volume and
fundraising benchmarks. According to an article written by
Kosaku Narioka, published in the The Wall Street Journal
on November 10, 2014, Japan has raised only ¥630 billion
(US$5.3 billion), or 1% of the world’s total private equity
market, despite being the world’s third-largest economy.
This low level of investment activity is rooted in managers’
unwillingness to execute mergers and acquisitions (M&A)
due to a risk-averse culture and negative perceptions
of private equity. However, recent demographic shifts
and international competition are forcing managers to
reconsider their strategies, opening the door for infusions
of private equity capital and management expertise.
74
Japanese Perceptions of Money and Risk:
A Cultural Heritage
Culturally, the Japanese identify money as spiritually
unclean, a precept that originates from the Edo period from
1603 to 1868. On the basis of the Confucian values that
came to Japan by way of China, the Tokugawa government
of that era enforced a tiered social order that placed
merchants at the bottom of society because they produced
wealth without creating anything of tangible value.
While this formal hierarchy was abolished long ago, these
traditional values are still recognized by many modern-day
Japanese, and anything perceived as financial engineering
with the objective of profiting at another’s expense
is frowned upon. Private equity investment is often
interpreted in this way because investors are willing to fire
unnecessary employees or discontinue underperforming
business operations to attain financial gain.
The cultural traditions of Japan and the real estate
catastrophe that followed the country’s economic
downturn in the 1990s have broadly impacted Japanese
decision-making in the face of uncertainty. Japanese
managers are largely unwilling to engage in risky M&A
transactions, preferring instead to stay the course. Wouldbe sellers view offers that do arise with suspicion: Is this
buyer going to fire all of my employees for personal gain?
The effect of these attitudes on Japan appear in a wide
range of economic indicators. As disclosed in the 2015 Flow
of Funds report compiled by the Bank of Japan, Japanese
households currently hold 51.7% of their assets in liquid
currency and deposits, which contrasts sharply with the
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
13.3% of the United States. Stock ownership is similarly
disparate. Only 10.8% of Japanese assets are invested in
shares and equities, compared with 34.3% in the United
States. Based on the 2014 investment banking league
tables published by Thomson Reuters and nominal GDP
data published by the IMF for 2014, investment banking
fee revenue represents only .09% percent of the Japanese
economy, compared with .28% of the U.S. economy.
Japanese investors are wary of not only investments in
private equity, but also of liquid, publicly traded equity.
The pervasive aversion to risk in modern Japanese society
is rooted in the burst of the Japanese bubble in the early
1990s. Heavy speculation in real estate, fueled by a loose
monetary policy and distorted incentives provided by
the legal system, led to all-time record-high levels of the
Nikkei 225 index. The crash resulted in the destruction of
¥2 quadrillion ($18 trillion) in wealth, leading to economic
stagnation that continues to this day as part of what is
termed the Lost Two Decades.
The pervasiveness of Japanese risk aversion is difficult
to overstate. A December 6, 2012, article by Bloomberg
notes that while Japan’s population is less than half that of
the U.S., the Japanese spend almost as much as Americans
do on life insurance policies. Because of the financial
complexity and illiquidity of private equity investments,
these policies are often perceived as high risk by Japanese
institutional investors.
A Renewed Focus on Corporate
Governance and Shareholder Value
The Japanese have long placed the needs of other company
stakeholders above returns to shareholders. After
World War II, a system of lifelong employment became
widespread, whereby employees gained seniority within a
company as they aged. Firing employees was both legally
complicated and socially taboo. Consequently, the boards
of directors of many companies became populated with
executives who were promoted through this system.
While this served the Japanese economy well during
the post-war miracle, it has had a detrimental effect on
corporate governance. Japanese companies have the
lowest average governance ranking within developed
markets, and only 11% of Japanese boards have female
Growth Strategies in a Global Economy
members, as noted in an April 10, 2015, article by
Bloomberg Intelligence analyst Gregory Elders.
In a June 6, 2015, article, The Economist reported that
only 274 of approximately 40,000 directorships are held
by non-Japanese citizens. This leads to boards that largely
affirm management decisions, suffer from groupthink and
maintain an insular mindset that limits growth, inhibits
capital efficiency and detracts from shareholder value. This
poor corporate governance and the low return on equity
within Japanese firms have long been decried by foreign
investors.
More recently, among Prime Minister Shinzo Abe’s
attempts to stimulate the Japanese economy and attract
foreign investment, a number of structural reforms have
been passed that target corporate-governance practices.
A governance code introduced in June 2015 requires a
minimum of one independent director, while the country’s
financial regulatory authority has joined the Tokyo Stock
Exchange in calling for a minimum of two.
Japanese investors are wary of not
only investments in private equity,
but also of liquid, publicly traded
equity.
Firms that do not meet these requirements are required to
provide public explanations for their inability to do so — an
embarrassment that no public-relations department wants
to face. The JPX-Nikkei 400 stock index, introduced in
2014, tracks only companies that rank among the top 400
on the Tokyo Stock Exchange, based on profitability and
corporate-governance metrics.
Another key element of corporate-governance reform has
been a push to reduce the cross-shareholding arrangement
between Japanese banks and their clients. This practice
dates back to the post-World War II economic expansion,
when Japanese industries used cross-shareholding to
form organizations called keiretsu, which insulated
their businesses from foreign investment, stock-market
fluctuations and periods of slow business.
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While Japanese banks have continued to reduce their
cross-shareholdings since 2002, ¥15 trillion (US$130
billion) of market value remains tied up in these
investments. In addition to the pressures from corporategovernance reform, financial institutions face strict
new capital requirements under the upcoming Basel III
standards, which will classify these holdings as risky assets.
The reduction in cross-shareholdings has increased both
the percentage of shares owned by foreign investors
and the pressure on Japanese firms to improve their
governance practices and return on investment.
While the sluggish Japanese
economy has been a burden for
many, the emerging private equity
market has created pockets of
opportunity for firms that are poised
and ready to take action.
These shifts in the Japanese market have had a significant
impact on the attitudes toward investors by companies,
which feel increasing pressure to use ¥227 trillion ($1.9
trillion) in cash holdings effectively or disburse it to
shareholders who can redeploy this capital more efficiently.
According to a survey of Japanese CEOs, published by
Nikkei in 2014, 46.6% are preparing to pursue, proactively
pursuing or are in negotiations for an M&A transaction,
compared with 31.0% three years earlier. This increased
willingness to execute M&A has been a significant boon for
the private equity industry, which closed a record ¥2 trillion
($18 billion) in exits during 2014. This change in behavior is
also expected to lead to an increased number of corporate
divestitures in future periods.
The Future of Private Equity in Japan
Despite the speed bumps ahead for the Japanese economy,
there are a number of opportunities that may pave the
road for increased private equity activity going forward.
The succession of family-owned businesses, for example,
has proved beneficial to private equity funds that find
themselves in the right place at the right time.
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Many of Japan’s 3 million family-owned businesses trace
their origins to the period of record economic growth
the country experienced after World War II. Driven by
cultural attitudes that value tradition and family lineage,
management of most of these businesses was passed on
to second-generation owners. However, demographic and
cultural shifts are increasingly complicating the transition
from the second generation to the third. First, the country’s
fertility rates, which rank among the lowest in the world,
result in fewer candidates for succession. Second, Japanese
youth’s recent recognition of Western values, such as
independence and individualism, lead many potential
successors to follow their passions elsewhere. Narioka’s
article notes that about 60% of the 34,000 family-owned
companies managed by owners ages 60-64, and more than
50% of 31,000 such businesses with owners ages 65-69,
have no successor.
In addition, the Japanese tax code is causing more familyowned businesses to question their succession plans. As
Bloomberg Business reported in an October 29, 2014,
article, Japan ranks behind only France as having the
highest inheritance tax rate in the world — at 55% — and
recently decreased the total value of exempt estates from
approximately ¥55 million (US$460,000) to ¥33 million
(US$280,000). As a result, private equity firms are gaining
traction as a viable succession option in Japan. In the Japan
Buy-out Market Review, the Japan Buy-Out Research
Institute Corporation reports that founder successions
represented nearly 50% of all buyout transactions executed
in the country in 2014. Nevertheless, the cultural hurdles
remain high.
Another silver lining to the economic challenges facing
Japanese firms is the expected boom in the health care and
pharmaceutical space. In 2014, one in every four Japanese
citizens was above 65, a problem that will inevitably put
a strain on drug manufacturers, hospitals, long-term care
facilities and other institutions. The problem is exacerbated
by the Japanese government’s reluctance to allocate more
money to address the problems of an aging society.
In 2005, Japan changed the law regarding pharmaceutical
manufacturing to allow pharmacy drug holders to
outsource 100% of drug manufacturing. Despite this
obvious cost-cutting opportunity, only 8% of the current
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drug manufacturing is outsourced, compared to the global
market average of 18%. Seeking to capitalize on this
opportunity, Baring Private Equity Asia acquired Bushu
Pharmaceuticals, Japan’s leading contract pharmaceutical
manufacturer, for ¥77 billion ($668 million). The deal
was the largest acquisition in the health care sector
in Japan in 2014. Baring Private Equity Asia aims to
promote outsourcing in Japan to lower the overall cost of
pharmaceuticals.
Another problem associated with the aging society in
Japan is the shortage of senior care facilities. According to
Bloomberg, more than 400,000 people are on the waiting
list for a nursing bed in Japan, a problem which comes in
large part from younger generations of Japanese eschewing
traditional values that stress the obligations children have
to their parents. In 2014, Asia Investment Partners (AIP)
Growth Strategies in a Global Economy
collaborated with the Japanese government and various
financial institutions such as Daiwa Securities Group to
launch Japan’s first health care real estate investment trust
(REIT) on the Tokyo Stock Exchange. According to CEO
Barry Hirschfeld, the fund has been used to build a nextgeneration senior housing facility that is also providing a
nice return for AIP’s investors.
While the sluggish Japanese economy has been a burden
for many, the emerging private equity market has created
pockets of opportunity for firms such as Baring and AIP
that are ready to take action. After a long history of
resistance to private equity funds in Japan, it seems that
the winds of change are finally starting to blow in the East.
This article was written by Eric Detweiler, Paul Moss and
Ruiheng Wang, members of the Lauder Class of 2017.
77
Breakfast in China: How 1.4 Billion People Start
Their Day
For 1.4 billion Chinese, the foods that fuel the day are markedly different than what is eaten for
breakfast in the United States. However, there is evidence that suggests these preferences are
slowly morphing.
Nearly 40 years after China initiated reforms and opened
its doors to the rest of the world, the influences of Western
cuisine have become clearly visible. In Shanghai’s trendy
French Concession area, it may be easier to a find a glass
of Riesling than a cup of Longjing tea. In Beijing’s Sanlitun
Village, venues offering Euro-American pub food have
begun to outnumber Chinese restaurants. Fried-chicken
giant KFC now has over 4,800 restaurants in mainland
China, spread across more than 1,000 cities.
Anyone who has taken a morning
walk down the street of a bustling
Chinese city can attest that Chinese
breakfast preferences are very
different from Americans.
Even in a rapidly modernizing China, however, some things
remain sacred. Chinese breakfast — the way more than
1.4 billion people start their day — has remained largely
immune to Western influence. Twelve hours before
Americans sit down to their cereal, toast and eggs every
morning, the Chinese tuck in to breakfast foods like zhou
(hot rice porridge), baozi (steamed buns) and youtiao (fried
dough sticks). Why are breakfast habits on each side of
the Pacific Ocean so different? Through interviews with
experts, analyses of survey data from breakfast eaters in
both countries and research into the origins of culinary
practices, this article highlights the key historical and
cultural factors that lead people in China and the U.S. to
start their day as they do.
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What’s for Breakfast and Why?
It is, of course, difficult — if not impossible — to conduct
an exact comparison of American and Chinese breakfast
preferences, given the degrees to which they vary across
respective regional, age and demographic groups. However,
responses to survey questions and the authors’ own
experiences suggest clear distinctions between what
constitutes “traditional” breakfast foods in both countries.
According to a survey conducted by ABC News in 2013,
the most common breakfast foods consumed in the U.S.
were (in order of popularity): coffee, cold cereal, juice, milk,
bread, eggs, fruit, hot cereal tea and breakfast sandwiches.
Anyone who has taken a morning walk down the street of
a bustling Chinese city can attest that Chinese breakfast
preferences are very different. As Financial Times reporter
Patti Waldmeir puts it, “even the most Westernized
Shanghainese queue up [every morning] before bamboo
towers of steamed buns, spitting woks of crispy bottomed
dumplings and steaming vats of rice gruel, to eat food that
proudly declares its Chineseness.” Coffee drinkers, while
certainly present in China, are still dwarfed in number
by drinkers of hot dou jiang (soymilk), sold in small plastic
pouches on nearly every street corner. Western cereals
like Corn Flakes, while eaten on occasion in China, are
hardly considered a “go-to” breakfast food the way a hot
bowl of huntun (wonton) soup, a steamed mantou bun or
a fried jianbing (egg pancake) are. What accounts for this
difference?
One reason may be historical agricultural practices.
Traditionally, the vast majority of Chinese farms produced
only crops and vegetables, such as rice, wheat, sorghum
and soybeans. Livestock production, which was far more
land- and cost-intensive, was found less often. This trend
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held true during more recent history, such as the Mao
Zedong era, when periods of famine and food scarcity were
common. As a result, carbohydrates and vegetables have
historically comprised the bulk of Chinese meals, while
meat has been consumed in smaller quantities and mostly
for special occasions. Although meat is widely available
today and no longer cost-prohibitive for most Chinese,
a large segment of China’s aging population comprises
older adults who lived through those times of scarcity and
continue to eat variations of the carbohydrate-heavy meals
they ate during their younger years. This may explain why
foods like zhou, baozi and youtiao remain so popular.
from food items that are actually healthy.” As a result, many
Chinese focus more on the taste of food and how filling
it is and less on the nutritional value and composition of
the ingredients. A recent survey of predominantly young
Chinese breakfast eaters found that a combined 44%
cited food’s flavor, color, scent or how filling it is as the
most important criteria for choosing their breakfast. This
suggests that the basis for breakfast-food selection in
China may be less scientific and linked more strongly to
historical and cultural factors. Or as Waldmeir put it, “at its
best, breakfast is not just food, it is more like love.”
In comparison, over the last several decades in the
U.S., breakfast habits have been far more reactive to
developments in nutritional research. As the International
Food Information Council (IFIC) Foundation notes, from
1965 to the early 1990s, American breakfast habits
gradually shifted from higher-fat foods such as eggs and
meat to lower-fat foods such as cereals and breads as
research showed certain types of fats may be linked to
heart disease. More recently, consumption of foods such as
eggs is once again on the rise as a result of newer research
suggesting certain types of cholesterol may be healthier
than originally thought and touting the muscle-building
benefits of increased protein intake.
Carbohydrates and vegetables have
historically comprised the bulk of
Chinese meals, while meat has been
consumed in smaller quantities and
mostly for special occasions.
The Chinese have conducted nutritional studies and
launched many initiatives of their own. China’s National
Health and Family Planning Commission recently
introduced the National Program for Food and Nutrition
(2014-2020), which aims to modernize how the Chinese
think about nutrition and to provide guidelines on food
consumption. Such efforts, however, rarely seem to impact
the dietary habits of China’s general public. According to
a recent study of consumers in Chengdu, even though the
majority of respondents indicated they wanted to purchase
foods with good nutritional content, 85% stated they could
not make sense of the nutritional information on product
labels.
Nutrition expert Judy Yang, currently a technical director
at NutraSweet in Beijing, agrees, “While many Chinese
understand the importance of nutritional values in
breakfast, they lack the knowledge and ability to choose
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Origins of the Chinese Breakfast
This Chinese breakfast “love story” started long ago.
Many of the breakfast foods commonly eaten in China
today can be traced back to early Chinese civilization.
Zhou, a breakfast staple across China, has been eaten
for thousands of years. The mythical Yellow Emperor is
believed to have mentioned millet zhou during his reign in
the 28th century BCE.
Youtiao, a fried dough stick that often accompanies zhou,
has been eaten in China since the 11th century Song
Dynasty. The Cantonese name, which translates to “oilfried devil,” is a reference to Chancellor Qin Hui, who along
with his wife betrayed the Song Dynasty’s General Yue
Fei. The twisted dough stick’s shape is said to represent
the couple, with two long pieces joined at the “hip,” fried in
symbolic punishment for their treachery.
Other typical Chinese breakfast items are based on recipes
that were introduced — or influenced — by foreign cultures.
The Jurchen, Mongolians and Manchus all brought their
respective culinary traditions as they entered China. This
helped to shape what the Chinese thought of as their
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own indigenous cuisine. Johann Adam Schall von Bell, a
Jesuit missionary who introduced many mathematical and
astronomical ideas to the Qing Dynasty court, also served
his friends a wafer-like pancake, or gaufrette, in the 17th
century. Similar pancakes remain a common breakfast
street food across China.
Historically, Chinese breakfast in rural areas had little
variety, often consisting of the same dishes served at other
meals throughout the day. In cities, however, a greater
diversity of people and cultures, as well as relatively higher
economic prosperity, led to a greater variety in breakfast
choices. Early accounts of life in Hangzhou during the
Southern Song dynasty, prior to the Mongol invasion,
describe an array of breakfast choices, including “fried
tripe, pieces of mutton or goose, soups of various kinds, hot
pancakes, steamed pancakes and iced cakes.”
China may be in the early stages of
a gradual shift from breakfasts high
in carbohydrates, fats and sodium to
early-day meals with more balanced
nutritional content.
This urban-rural disparity in breakfast food variety
and nutritional content continues to this day, largely a
result of China’s massive urban-rural wealth gap. In her
book “Changing Rice Bowl,” Elizabeth Leppman studies
this nutritional discrepancy by surveying urban and
rural residents of Liaoning Province about their dietary
preferences. According to Leppman, while the consumption
of meat, eggs and dairy products in cities has increased
dramatically in recent years, the costs of these products
have restricted consumption in relatively poorer rural
areas. As a result, protein deficiency still constitutes a
serious problem in parts of China.
Origins of the American Breakfast
The origins of the traditional American breakfast are
similarly rooted in early U.S. history. Corn was a Native
American staple food, knowledge of which was passed
80
along to the early European settlers who incorporated it
into their breakfast diet. Those same settlers soon began
turning ground cornmeal into baked and fried cornbread,
johnnycakes and hush puppies, dishes that would later
become associated with the American South’s working
class. The practice of curing meat was also shared by the
Native Americans, and these meats became an important
feature of the early American breakfast.
Even breakfast cereal, the invention of which many
incorrectly associate with the increased popularity of
products such as Wheaties in the mid-20th century,
has relatively deep roots. According to Heather Arndt
Anderson, author of “Breakfast: A History,” cereal was
created in the late 19th century as part of a backlash
against the then-current trend of beginning the day with
large servings of meat and other rich foods. In 1894, John
Harvey Kellogg invented the flaked breakfast cereal, which
became a hit at his health resort in Battle Creek, Michigan.
He soon patented his cereals and began producing them
under the Kellogg’s brand name, but this did little to stop
his chief competitor, C.W. Post, from founding Post Cereals,
which offered similar products.
During World War II, egg and meat rationing led to the
introduction and popularity of easy-to-make breakfast
alternatives such as Bisquick, Cream of Wheat and Quaker
Oats. The rise of feminism in the 1960s resulted in popular
ready-made, prepackaged breakfast foods such as PopTarts (introduced in 1964), which allowed mothers to
spend less time in the kitchen. During this same period,
the U.S. introduced federal-level nutrition programs such
as the School Breakfast Program and Child Nutrition Act
of 1966. These new guidelines led to the definition of a
“balanced breakfast” and helped parents determine what
to feed their children in the morning. During the 1970s
and 1980s, the declining price of microwave ovens led to
a surge in the popularity of frozen breakfast foods, while
fast-food restaurants began to market items such as the
Egg McMuffin.
Today, increasingly health-conscious American consumers
have begun to reject processed breakfasts in favor of
fresh fruits, vegetables and whole-grain cereals. The
IFIC’s 2014 Food and Health Survey determined that
71% of Americans consider “healthfulness” a key factor
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when selecting food, up 13 percentage points since 2006.
Updated federal guidelines for healthy eating reflect these
changing standards. In 2012, with the support of first lady
Michelle Obama, the Nutrition Standards for School Meals
were revised to include more fresh fruits and vegetables
in children’s diets and to minimize consumption of heavily
processed foods.
The Future of the Chinese Breakfast
Consistent with nutrition experts’ claims that the Chinese
have started to pay more attention to their diets, Chinese
survey respondents indicated that nutritional content is a
major consideration when choosing breakfast. Many Chinese
now consider milk, yogurt, fruit and boiled eggs as healthy
breakfast options, which may indicate that the Chinese view
protein and vitamin content as important considerations.
Indeed, China may be in the early stages of a gradual shift
from breakfasts high in carbohydrates, fats and sodium to
early-day meals with more balanced nutritional content.
Younger adult Chinese also indicate that they value
convenience when choosing what to eat for breakfast.
Morning is a busy time, which distinguishes breakfast from
the typically social activities of lunch and dinner in China.
Nearly 40% of those surveyed indicated that they use their
phones while eating breakfast.
This convergence of the perceived health value of certain
Western foods and the demand for convenience may lead one
Growth Strategies in a Global Economy
to assume that Western-style offerings at major American
breakfast establishments in China, such as McDonald’s and
KFC, are becoming more popular. In reality, this may not
be the case. According to an October 2012 article in The
Economist and findings from research firm Mintel, only
21% of the Chinese populace eats Western fast food in the
morning, a stark contrast with the booming popularity of
those restaurants’ lunch and dinner offerings. Although most
Western fast-food chains have introduced Chinese breakfast
options to their menus, these adjustments may not be enough.
The popularity of local fast-food chains and shops serving a
Chinese-style breakfast still far outweighs that of Western
chains. So, while more Chinese people may consider traditional
Western foods to be healthy, the overall penetration of
Western dishes into the Chinese diet remains low.
It is unclear just how much this will change over time. While
more Chinese eat Western breakfast foods than a generation
ago, survey data suggest that this trend may not be driven
solely by the changing preferences of young people. Instead,
China’s breakfast tastes across age groups appear to be
evolving, and while some Western breakfast items will
become more popular, the new Chinese breakfast will more
likely resemble a hybrid between the Chinese and Western
styles, but with a higher nutritional value.
This article was written by Jon Delikat, Shu Liu, Daniel Odette,
and James Randall, members of the Lauder Class of 2017.
81
Le Gaspillage Alimentaire: Stopping Food Waste
in Europe
France is trying to tackle one of the most pervasive problems faced by industrialized nations —
food waste.
About one-third of the food produced in the world is lost or
wasted, according to the European Environment Agency.
In France, the rate of food waste has doubled since 1974,
far outpacing the population growth during the same time
period.
The scope of the problem can be illuminated through a
few key government-published figures: One-third of the
food produced and purchased in France is wasted before
reaching the dinner table. Thirty-seven kilograms of food
are lost each second. For every 20 kilograms of food that
is thrown away, 7 kilograms are still consumable. From a
financial perspective, food waste in France results in the
yearly squandering of 100 to 160 euros per person, or 12 to
20 billion euros nationwide.
While food waste certainly
represents a missed opportunity
to feed the hungry, it also results in
the unnecessary exhaustion of land,
energy and labor resources.
While food waste certainly represents a missed
opportunity to feed the hungry, it also results in the
unnecessary exhaustion of land, energy and labor
resources. There are myriad challenges for countries
struggling to develop strategies to address food waste,
but France is poised to lead the way through the combined
efforts of the government, nongovernmental organizations,
industry players and individual activists. A recently
enacted law aimed at curbing food waste, tougher industry
standards and a national campaign to change the culture
and thinking around food waste are helping France tackle
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the problem and allowing it to serve as an example for
others.
Working Together
To address the problem, it is important to first understand
the underlying economic and aesthetic reasons for food
waste. Fruits and vegetables viewed as sub-par due to size
requirements, bruising or other deformities, or arbitrary
expiration dates, account for much of the food left by the
wayside.
According to anti-waste activist and former agribusiness
scientist Marie Bondroit, supermarkets routinely reject
produce items that are not of a minimum size or have
external marks, rendering them “unattractive” and leading
farmers to leave these otherwise perfectly edible pieces
of food in the fields. In addition, many consumers rely on
expiration dates to guide their purchases. Yet experts
say that food-processing centers often set these dates
arbitrarily, for example, affixing expiration dates two weeks
apart on crates of food leaving the factory only a day apart.
In response to this colossal challenge, French NGOs,
government representatives and activists are working
to raise awareness and reduce waste at every level of
the supply chain. Headlines around the world praised
the unanimous passage on May 22, 2015, of a sweeping
French law designed to stop food waste. Popularly known
as the Derambarsh law — after its largest proponent,
Arash Derambarsh, a municipal council member in the
Paris suburb of Courbevoie — it prohibits supermarkets
from throwing away edible food. This practice has drawn
considerable attention because many large chains usually
pour bleach on discarded goods to dissuade homeless
and hungry Parisians from scavenging through the stores’
dumpsters. The law formally takes effect June 30, 2016,
allowing supermarkets a year to prepare.
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Beyond the government edict, the French state has
also attempted to influence the public to reduce waste
by means of subtle public-information campaigns.
Advertisements showing a deformed potato with the saying
“my beauty is on the inside” are designed to discourage
people from discarding food based on the item’s external
appearance because aesthetics often have no impact on the
food’s nutritional value, ripeness or taste.
Politicians’ pursuit of legitimacy on this issue illustrates just
how important it has become in France. While Derambarsh
has been the subject of flattering media portrayals, activists
privately express their concern that he is taking credit for
a movement that goes beyond his contributions. Instead,
they point to Guillaume Garot, a socialist and member of
the National Assembly, as the movement’s true leader.
Garot is frequently present at anti-food-waste rallies and
coordinates directly with activists. “Garot said that he
needs our help in terms of logistics and distributing food,”
Bondroit said.
Activists and Social Entrepreneurs Lead the
Charge
Even before the recent surge in government activism
against food waste, nonprofit organizations and social
entrepreneurs had successfully sought solutions. Antoine
Delauney, founder of DiscoSoupe, recounts the origin of his
unique organization: “It started as a joke. In 2011, a friend
and I went to a rally in favor of slow foods and against
processed foods in Berlin. Some attendees wanted to take
discarded potatoes and make soup. We started peeling the
potatoes and playing music while making soup.”
From that experience, Delauney expanded a one-time
cook-off into an international movement. He founded
DiscoSoupe out of MakeSense, a social entrepreneurship
incubator in Paris, in March 2012. DiscoSoupe provides
tools to local activists to organize independent cookoffs using nearly discarded, but still healthy and edible,
ingredients to feed those in need. Living up to the disco
element of its name, each event is accompanied by music
from local DJs or bands.
simultaneous cook-offs. Brazil is the movement’s secondlargest country, thanks to the time Delauney spent there to
implement the program with local leaders.
DiscoSoupe is not alone in its fight against food waste.
Members of guerilla group Gars’pilleurs (the Looter Guys)
rummage through supermarket waste bins and redistribute
food for free on the street the following day. YesFoodCan
is another French venture that is borrowing innovative
ideas from the emerging world to try to solve food-waste
problems in Europe.
Given the lack of clarity about how
disposed food will find its way to the
end users, it is a real concern that, in
the interest of keeping down costs,
supermarkets will view food banks as
recipients of their garbage.
Co-founder Florian Hug-Fouché traveled across 20
African countries in one year, documenting examples of
low-tech solutions to limit spoilage and other common
causes of food waste. He said he thinks “Western countries
could benefit from ‘reverse innovation.’ The Canari
Frigo, is a low-cost, low-energy Burkinabe product to
keep food and medications cold, drawing on traditional
technologies of clay pots.” Indeed, emerging markets’ need
to leapfrog through development has provided numerous
such examples of cunning innovation that Hug-Fouché
documents on YesFoodCan’s blog.
Curiously, each of these nonprofits presents its mission in
terms of reducing waste rather than feeding the hungry.
The groups’ leaders specify that, based on their experience,
participants are more likely to feel motivated to respond
to the problem of food waste when it is viewed as an
economic issue, which they have the power to solve, and
not as a social issue that dwarfs their ability to contribute
individually.
DiscoSoupe events are now held in 60 cities spanning
six countries. In France, up to 20 cities have hosted
Growth Strategies in a Global Economy
83
Are Chefs the Answer?
Throughout history, France has been viewed as the center
of haute culture, a reference point for luxury and fine
living. It has also served as the Michelin Star of sorts in the
culinary world, defined by richness, precision and grandeur.
However, French cuisine is in transition. There is a renewed
focus on fresh, organic, local food as chefs hope to take
advantage of the terroir, or the land, and its bounties, thus
reducing waste.
This movement has reached not only individual grocery
shoppers, but also younger chefs and fledgling restaurants,
leading them to change their menus and operations. Chef
William Groult of the Alain Ducasse Cooking School in Paris
says some chefs have moved toward a smaller fixed menu
dedicated to freshness to meet both social demands and
reduce costs. He noted one chef he had worked under who
provided only one garbage can in the kitchen and required
all the staff to show their waste to him prior to throwing it
in the trash. He could then ensure that all the salvageable
ingredients were reused.
The government still has much
work to do. It must listen to various
constituents and promulgate policies
that do not simply shift the burden
of food waste from one actor to
another.
Beyond the kitchen, restaurants are working to change
public opinion regarding the level of waste, the utility of
various animal parts and the value of take-away meals. For
example, Groult notes that an eco-friendly restaurant in
the U.K. gathers the food left behind by individual diners
and weighs what remains on the table. By providing
diners with a visual of the level of waste, restaurants may
also encourage these customers to take leftovers home.
Although the “doggy-bag” was once taboo in France, more
and more diners at chic Parisian restaurants, cognizant
of their capacity to reduce food waste, are becoming
comfortable asking to have their leftovers wrapped up and
taken home.
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Finally, along with efforts to return to the terroir, a
movement that encourages individual consumers to cook
more for themselves has taken hold. In line with this is an
effort to educate individual consumers about the uses of
various animal and plant parts. These concepts of “noseto-tail cooking” and “root-to-stalk cooking” prompt home
cooks and restaurants to employ more than just the center
cut when cooking a pig, for example. When combined with
legal and regulatory changes, these cultural shifts can have
a major impact.
Industry and Commercial Opportunities
The sheer number of industry players affected by the
Derambarsh law offers some perspective on the extent
of its implications. The supply chain goes from the farms
to the supermarket chains and, finally, to the food banks.
Three players dominate the supermarket industry in
France: Carrefour, Auchan and Casino. Historically, they
have been among the largest wasters of food, disposing
of 20 kilograms per day per store with over 7,000
supermarkets in France.
While the Derambarsh law, as currently written, targets
the reduction of food waste at supermarkets, it does not
directly address the role of the farms in the supply chain.
Some experts are concerned that by not considering
the relationship between farms and supermarkets, the
regulation misses the opportunity to make a substantive
difference in reducing overall waste. The negotiation
power that supermarkets have over farms allows them to
adjust their orders on a daily basis. By not having adequate
visibility, farms often overproduce, which results in
considerable waste from the outset.
Another concern is that the law may just shift responsibility
from the supermarkets to the food banks. It does not
address who is responsible for delivering the food nor
does it offer support to food banks for dealing with this
new abundance. Food banks rely on volunteers to sort and
distribute food, and volunteers are in short supply.
Given the lack of clarity about how disposed food will find
its way to the end users, it is a real concern that, in the
interest of keeping down costs, supermarkets will view
food banks as recipients of their garbage. Marie Bondroit
notes “There are perverse incentives. You cannot just treat
food banks like waste bins.”
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The Derambarsh law and similar efforts to reduce food
waste have sparked an entirely new industry. Delauney and
his colleagues at MakeSense work to bring entrepreneurial
ideas with a socially conscious goal to fruition. One such
success story is Re-Belle, a jam producer that uses 100%
unsold fruits that are discarded by supermarkets. The
company’s name is a play on words, connoting both the
rebellious nature of social entrepreneurship and rebeautification, as belle means beautiful in French.
One area of untapped potential to come from the law will
be refrigerated transportation. Le Chainon Manquant and
A.N.D.E.S. already have service lines with a similar offering
specifically for discarded food. As the law continues to take
shape, many are eagerly waiting to see what new business
ventures it will produce.
Is a Solution in Sight?
While different communities in the French food-production
space – the government, NGOs, restaurants, supermarkets,
farms and consumers – may disagree on how best to reduce
waste, experts agree unanimously that the heightened
public discourse surrounding the issue is a positive step
toward solving the problem. The government still has
much work to do. It must listen to various constituents and
Growth Strategies in a Global Economy
promulgate policies that do not simply shift the burden of
food waste from one actor to another.
NGOs must translate their social activism into sustainable
entrepreneurial methods that can support themselves and
ensure the lasting impact of socially conscious consumption
habits. Restaurants must view this as not simply a social
problem, but also an economic one, ensuring that resources
are not wasted in pursuit of food that never reaches the
diner’s plate. Supermarkets and farms must come together
to implement more sensible standards on, first, what
produce items are deemed worthy of store shelves and,
second, not leaving any viable products on the field.
Finally, consumers must demand more of all the actors in
the value chain and seek greater social responsibility and
higher-quality food.
France has been at the helm of the fight against food waste.
As other developed and developing countries follow suit, it
should not rest on its laurels but must continue to push for
a more equitable and economical solution to food waste.
This article was written by Max Ducharme, Stephen Snyder and
Sophie Thompson, members of the Lauder Class of 2017.
85
Female Entrepreneurship in China: Women Hold
up Half the Sky
China’s communist ideology assigns equal status to men and women in society, which boosts
women in business. But Chinese women still have a long way to go.
“Women hold up half the sky.” — Mao Zedong, former Chairman
of the Communist Party of China
Female Expatriates as Entrepreneurs in
China
One of Mao Zedong’s many legacies is the affirmation
that women and men share equal status in society. Under
his leadership as founder of the People’s Republic of
China, women were strongly encouraged to enter the
workforce and take jobs that were traditionally held by
men. Today, while preferential bias toward having sons in
order to preserve the family name still persists in many
Chinese families, women in China arguably experience
less inequality than those in many other developed
countries. China boasts one of the highest numbers of
female billionaires in the world and, according to a survey
by the U.S. audit, tax and advisory firm Grant Thornton,
China is one of the highest-ranked countries in terms of
the proportion of women in senior management roles (38%
compared with 24% in the United States).
In 1978, the Chinese government began the “reformand-opening-up” movement. For the first time in decades,
China welcomed foreign investment, foreign businesses
and foreigners themselves. Since then, expatriates from
all over the world have immigrated to China to start new
lives, build careers and raise families. A number of these
expatriates are women who have become a new generation
of entrepreneurs there.
Women in China arguably
experience less inequality than those
in many other developed countries.
China boasts one of the highest
numbers of female billionaires in the
world.
One glaring omission, however, is a lack of institutional
legislation on gender discrimination in employment
and labor practices, which has led to frequent reports
of discrimination in hiring decisions as well as sexual
harassment in the workplace. This perhaps explains in
part the growing trend among highly educated women in
China to forsake the beaten path of climbing the corporate
ladder in exchange for the road less taken, the wild world of
entrepreneurship.
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Even though women in China still face overt gender biases
in their daily lives, female expatriates are often held to
a different standard and treated more respectfully than
native women. For example, Chinese women who have
chosen to pursue a career rather than get married and
have children are asked about their marriage plans and if
they would like to be introduced to single men. They are
subjected to the expectations of their families to marry and
settle down as soon as possible. Female expatriates are less
likely to be asked such questions.
Both foreigners and locals who have been educated abroad
often enjoy preferential treatment at home. If these
women make nontraditional choices, their decisions are not
scrutinized as much as they are for local women who are
born, raised and educated in China. This double standard,
for better or for worse, serves to remove some societal
pressures from female expatriates who start businesses in
China.
Several female expatriates have also turned their gender
into strengths that benefit their businesses. Stacy
Palestrant is the founder of Elite Scholars of China, an
educational consultancy that helps Chinese high-school
students apply to the best colleges in the U.S. She noted
that because she is female, she is able to be more maternal
with her students, a role that her husband and company
co-founder, Tomer Rothschild, would not be able to fill as
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
easily. Also, she serves as a strong female role model for her
female students. In their local schools, these students often
hear, “Girls can’t study math,” and similarly discouraging
remarks that lead them to question themselves, especially
as they soon must decide what to study in college.
Palestrant serves as an advocate and role model, showing
them what a strong woman can do and accomplish in the
world.
Many female expatriates have also turned their foreignness
into an asset. Because Palestrant has gone through the
college application process in the U.S. and knows how the
system works, she is uniquely positioned to be a successful
college consultant in China, where more and more families
are choosing to send their children abroad each year to
be educated. Randi Miller, an attorney who specializes in
international business law and another female expatriate
from the U.S., indicated that because of her law background
and former connections in the U.S., she can serve as a
liaison between China and the rest of the world and is
uniquely positioned to find projects that would interest
Chinese investors.
Foreign women also find that raising a family while
running a business in China is much more affordable
than it would be in the U.S. and many other developed
countries. Palestrant has had the same Chinese ayi, or
nanny, for seven years. This ayi has been with her family
through the birth of both of her children and the founding
of her business. Equivalent child care in the U.S. would be
prohibitively expensive, and neither Palestrant’s parents
nor in-laws could be expected to move to China to help take
care of the children. Because she has someone she can trust
to look after her children and do the housework, she has
more time and energy to dedicate to her business.
While many female expatriates have successfully started
businesses in China, many elements of traditional Chinese
society still pose barriers. While looking for funding for
her information technology business, Wharton graduate
Loretta Evans found that Chinese venture capital firms
are male-dominated and not used to having female
entrepreneurs come to them asking for funding. In their
minds, “their picture of success is not a woman,” she said.
Rather than focusing on the value of her business, they
make value judgments based solely on her gender. Evans
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has found fundraising in China as a female entrepreneur to
be extremely difficult, although perhaps no more so than it
would have been in the U.S.
Another factor standing in the way of expatriate female
entrepreneurs is the concept of guanxi, or relationships,
in China. To gain access to the right people, formal
introductions by a mutual acquaintance are expected and
frequently mandatory. Miller said male expatriates have
an advantage because the Chinese women they marry
have such connections. However, marriages between
female expatriates and male locals are far less common,
so these women must work extra hard to make these key
connections.
One glaring omission, however, is
a lack of institutional legislation on
gender discrimination in employment
and labor practices.
Local Women as Entrepreneurs in China
In addition to the elements that make China an attractive
environment for foreign female entrepreneurs, a number
of cultural and historical factors make China a surprisingly
supportive environment for native female entrepreneurs.
Enacted in 1980 – and amended in 2015 – the One Child
Policy had significant effects on China’s population
structure in terms of its age distribution and gender ratio.
Certainly, the cultural preference for boys has also led to
a marked imbalance in the gender makeup of the Chinese
population.
At the same time, perhaps counterintuitively, the policy
may have had an equalizing effect on the education of
both male and female children. With only one child to
raise, Chinese parents invest significant resources in
the education and upbringing of that child, regardless
of gender. Over the course of building her company,
Palestrant noted that Chinese parents have equally high
expectations of their children, whether male or female, and
devote as many resources as they can to their children’s
education. In the absence of this policy, parents might
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have invested more to educate their sons, leading to an
imbalance in the educational levels of boys and girls.
Apart from the equalizing effects of the One Child Policy,
China’s social and cultural contexts over the last 50 years
have led to an environment in which women are expected
and encouraged to work outside the home. Mei Zhang,
founder of the boutique travel firm WildChina, noted that
one of the legacies of the Cultural Revolution has been an
outward avowal of and belief in the equality of the sexes.
Indeed, the Cultural Revolution affirmed the equality of
women, who were assigned roles and jobs similar to their
male counterparts within their work units.
China’s social and cultural contexts
over the last 50 years have led to an
environment in which women are
expected and encouraged to work
outside the home.
Research has indicated that such a policy of “equality” has
imposed a significantly greater burden on Chinese women,
as they are expected not only to take on a full-time job but
also to take care of household duties upon returning home.
At the same time, this period of intensive, state-mandated
female participation in the workforce has rapidly lowered
social barriers for women who wish to enter the labor
market or to become entrepreneurs. Four decades after the
end of the Cultural Revolution, women in contemporary
China are fully expected to enter the workforce.
Complementing the relatively low social expectations for
women to stay at home has been the role of family ties
in alleviating the burden of motherhood. While foreign
female entrepreneurs cited the affordability of household
help, local female entrepreneurs repeatedly emphasized
the role of familial support in allowing them the time and
flexibility to focus on their businesses. The cultural focus on
the tight-knit cohesion of the extended family means there
is an expectation that grandparents will often step in to aid
in the care and rearing of children while the young parents
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continue to focus on their careers or work. For local female
entrepreneurs, this has given them significant freedom
to devote their time and resources to developing their
businesses.
At the same time, however, social and structural issues
continue to affect China’s climate for the emergence
of female entrepreneurs. With respect to access to the
financial and legal services necessary for setting up
a business, female entrepreneurs have encountered
varying levels of professionalism and discrimination.
Some entrepreneurs, including Zhang, believe female
entrepreneurs in China encounter the same scrutiny
as their counterparts do in the U.S., for example, having
to face similar but perhaps subconscious biases that
women are more emotional in running their businesses.
However, other female entrepreneurs believe the absence
of discussions about women in the workplace has led to
an environment that allows for inappropriate personal
questions. Lilian Li, founder of an online dessert shop, noted
that it would not be uncommon for potential investors to
ask bluntly about pregnancy or marriage plans.
Furthermore, most of the female entrepreneurs
interviewed acknowledged that many of the social and
cultural benefits they were able to enjoy in setting up their
businesses were limited to only a small segment of the
population. Zhang noted that it was still often only women
in the educated elite who had the ability to determine
whether and when to have children. Chen Hua, founder of
the online social media platform Jiecao, indicated that she
was lucky to have grown up in a family of intellectuals who
encouraged her to pursue her interests in education and
entrepreneurship. Less well-to-do families still do not have
the ability to encourage such freedom for their children.
Longstanding Obstacles in the Workplace
for Chinese Women
While China has come a long way in terms of promoting
gender equality, there is still much room for improvement.
Most notably, Chinese state-owned enterprises and local
businesses should adopt a strict and intolerant stance
toward discriminatory practices in the workplace and more
closely monitor gender ratios within their organizations
Knowledge@Wharton • The Lauder Global Business Insight Report 2016
and in senior management roles. It does not have to be
an act of charity. Studies have shown a clear correlation
between team performance and gender diversity within
a team. Furthermore, promoting a more equal workplace
will prevent a brain drain of female talent from local
Chinese companies and state-owned enterprises to
entrepreneurship or foreign multinational corporations
that employ strict anti-discrimination policies in the
workplace.
share a common vision — to succeed on their own merit.
They want to be viewed through a gender-blind lens rather
than receive preferential treatment. While Chairman
Mao’s slogan was clearly uttered with good intentions, by
extension it takes as a given that men are already doing
their part to “hold up half the sky.” Perhaps this assumption
should be questioned. Society would undisputedly be
better off if women’s contributions and their value in the
workplace are also taken as a given.
From the novice who bootstrapped her own online dessert
shop to the accomplished veteran who now owns a globally
recognized travel brand, female entrepreneurs in China
This article was written by Victoria Rui Cheng, Naga Tan, and
Wilson Wong, members of the Lauder Class of 2017.
Growth Strategies in a Global Economy
89
The State of the Arts: Realities and Implications of
France’s Cultural Subsidy System
To protect the importance of the arts in society, France supports cultural activities through a
system of government subsidies aimed at making them universally accessible. However, the
performing-arts industry remains closed, elitist and costly. By not adapting its subsidy system,
France risks a deterioration in the quality of the country’s arts programming.
In many countries, the performing arts represent a leisure
activity, a pastime or an upper-class luxury. In France, the
arts are an integral part of society. Indeed, the French
constitution lists culture as an essential right guaranteed
by law: “The nation guarantees equal access for children
The government’s subsidization of cultural activities
reflects an underlying belief in the perceived social and
economic benefits of the arts. In theory, nations that
support the arts reap the advantages of greater peace,
liberty and improved international relations, as well as
and adults to education, professional training and culture.”
Unlike other countries that allow the arts to occupy a
peripheral role, France makes art and culture a central part
of daily life.
economic gains such as direct profits, increased tourism
and the attraction of wealthy visitors.
Unlike other countries that allow
the arts to occupy a peripheral role,
France makes art and culture a
central part of daily life.
To protect the importance of the arts in society, France
supports cultural activities through a system of government
subsidies aimed at making them universally accessible.
Despite this lofty goal, reality paints a different picture. An
economic and social examination of the performing-arts
industry reveals the current subsidy system is inherently
flawed. Rather than increasing accessibility to cultural
activities, it renders the performing-arts industry costly,
inaccessible and elitist.
What exactly are the “performing arts” in France? Spectacles
vivants, which translates to “live spectacles,” describes any
performance that takes place in front of a live audience,
including theater, opera, dance and music. More than 5,000
such productions each year employ more than 130,000
professional artists, a number that has grown by 50% over
the past 15 years. It is an industry of public interest and
growth, occupying a visible and important role in French
society.
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In terms of the potential impact on society, the arts provide
a safe outlet for expressing opinions and releasing tensions.
In a state that values free speech, they represent an
intrinsic aspect of freedom of expression. Finally, the arts
serve as a gateway to communicating with other parts of
the globe. Partaking in the cultural activities of another
country is a means of understanding that nation’s people.
Building on these social benefits, the arts also provide a
nation with several economic benefits. The most obvious
of these is the profit accrued by cultural industries. Beyond
direct profits, there is also a vast network of indirect profit
through tourism. Artistic exhibitions attract tourists who,
in turn, promote growth in the related industries of food,
lodging and transportation. Finally, the arts play a role in
attracting and retaining the interest of wealthy visitors —
an upper class with disposable income to spend on local
goods and services. So, supporting the arts can lead to longterm economic growth.
The Economics of France’s Subsidy System
In France, the performing arts are subsidized heavily by
the state in order to promote social and economic benefits.
However, there is a sharp distinction between theater that
is subsidized by the state (théâtre publique) and theater
that is not (théâtre privé). The two-tiered financing system
is as much a product of the country’s pre-revolutionary
history as it is a result of the current attitudes toward
cultural accessibility. Under the Old Regime, the state
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had an effective monopoly over the theater. A production
involving dialogue between two or more actors could
not be staged without the monarch’s consent. Theater
was an elite institution that served to glorify France’s
highest cultural and political ideals. More popular forms
of entertainment — one-man shows, marionettes,
pantomimes, etc. – were largely free of state control. These
divertissements kept the masses entertained while posing
no real threat to the monarch’s authority. As a result of
these parallel histories, in France today one would be hardpressed to find a private theater staging a production of
Molière. Likewise, Broadway-style musical productions,
with their commercial soundtracks and big-name pop stars,
rarely attract state funding.
The system of public funding for the performing arts in
France is complex, with various funds allocated at the
national, regional and local levels. At the national level,
budgetary support is distributed through the Ministry of
Culture. From a budget of nearly €7 billion (US$ 7.5 billion)
in 2015, €668 million (US$ 717.6 million) was earmarked
to support the creation, production and distribution of the
arts. This constituted about a quarter of the public funding
for the performing arts in France, with the rest coming
from regional and local governments. In addition to direct
budgetary support, the state also subsidizes employment.
An actor in France is considered a salaried worker entitled
to generous social protections such as unemployment
insurance (l’assurance de chômage). To collect these benefits,
they must work a minimum of 507 hours every 10.5 months
— about 48 hours each month during the eligibility window.
Direct budgetary support for the performing arts,
combined with a generous unemployment insurance
structure, makes state support for the arts a costly
affair. A 2003 Senate report found that ticket prices for
performances at the national theaters ranged from €8
(US$8.59) to €16 (US$17.19), with the state contributing
an average of €85 (US$91.31) per ticket sold. Isabelle
Barbéris and Martial Poirson, professors at Paris Diderot
University and University Paris 8-Vincennes-Saint Denis,
respectively, estimated that public subsidies for the
performing arts at all levels of government amounted to
€21 billion (US$22.6 billion) in 2009 — a staggering amount
in relation to other developed countries such as the United
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States, where the budget for the National Endowment for
the Arts is $150 million. Ticket receipts in France amounted
to a mere 20% of their global costs. The remaining 80% of
these costs were covered by the state.
Public support for theater in France is likely to become
costlier still. The performing arts suffer from cost
disease, an economic phenomenon in which labor costs
tend to outpace productivity growth, diminishing the
overall quality and quantity of output. In most industries,
technological progress makes workers more productive,
leading to higher profits and salaries. However, this is not
the case with the performing arts. It still takes an actor
the same amount of time to perform a Shakespearean
production, regardless of how technologically advanced the
lighting or sound systems are. The production still requires
the same number of cast members, who are limited in the
number of performances they can physically present in a
single day. Yet wages have certainly increased — an actor
today enjoys a higher standard of living compared with
counterparts from 400 years ago. Cost disease can be used
to explain the tension today in France between grand ideas
of French cultural exceptionalism (l’exception culturelle
française) and budgetary realities, which begs the question
of whether the benefits of these subsidies justify their evergrowing costs.
The government’s subsidization
of cultural activities reflects an
underlying belief in the perceived
social and economic benefits of
the arts.
Subsidies Render Performances Less
Accessible
A proponent of the subsidy model may argue that
government support makes the arts more accessible
to the general public. However, this is not the case. The
performing-arts industry remains closed, elitist and
costly. According to Keti Irubetagoyena, a French theatre
producer and artistic director, “the public in France is very
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varied. You must know that already in France, theater, for
example the kind you can see at the ‘in’ festival in Avignon,
it’s very elitist, more and more so.”
By attempting to make the performing arts more
accessible to the public, the state in fact makes them less
so. Attendance continues to rely on the educated strata
of French society — the intellectual viewers who would be
likely to attend regardless of the existence of subsidies.
In France, more than 50% of those in the most educated
quartile have attended a performing-arts show in the
past 12 months. This suggests that members of the most
educated segment of French society are likely to go to the
theater whether it is subsidized or not.
An economic and social examination
of the performing-arts industry
reveals the current subsidy system is
inherently flawed.
The Private-patron Model as a Possible
Solution
Many performing-arts institutions in the U.S. regularly
tap into a network of loyal donors for financial support.
This difference underscores an important cultural divide
between the two countries. In the U.S., cultural institutions
such as music halls and performing-arts centers list their
donors in their programs and often display large plaques
of acknowledgement in prominent locations. This type of
attribution does not exist in France. For example, at the
Paris Opera House a single small plaque in the main lobby
is dedicated to l’Association pour le Rayonnement de l’Opera
national de Paris (AROP), an organization that collects
funds from private donors on behalf of the opera. Cultural
institutions in the U.S. raise funds overtly with events such
as benefit dinners and awareness campaigns; the French
system does not encourage this.
However, there is hope for the patron model in France.
According to a 2010 study by Excel and OpinionWay, a
Paris-based marketing institute, 21% of participants stated
they would donate to a cultural institution. This figure was
3% higher for participants age 60 or older. More than 30%
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of the respondents also indicated they would be likely to
donate to save a cultural work that inspired them.
The patron model has been successful in the artistic
domain in recent years. In 2010, the Louvre launched a
public-donation campaign to acquire “The Three Graces,”
a Renaissance painting by German artist Lucas Cranach
that is considered a national treasure in France. The
Louvre had only three-quarters of the funds necessary
for its acquisition. Thanks to 7,200 private donors and 10
companies, the museum was able to complete the $5.2
million purchase.
Even though this was a painting rather than a performance,
and not every work is considered a national treasure, this
early success was encouraging and points to the potential
for the patron model in France. With broad support, private
donors reinvigorate the arts with a new sense of prestige
and perpetuate them as something special and desirable.
An added benefit of this model is that private donors
are a more flexible funding source. Depending on their
needs, cultural institutions can call on them more readily
and more frequently. The Metropolitan Opera in New
York, for example, projects live performances in movie
theatres across the globe to increase publicity and expand
its audience. In doing so, it is able to tap into an enormous
source for potential funding.
The Way Forward
By not adapting the subsidy system, France risks a
deterioration in the quality of the performing arts. If shows
become increasingly inaccessible, alienated audiences may
turn to other forms of art instead, including those from
cultures outside France. The government must alter the
current system to avoid this scenario. If the subsidies were
removed entirely, the system would collapse or private
donors would have to step up to provide the totality of
funding. These options are not mutually exclusive, and a
transformed model that incorporates both, such as that in
place in the U.S., may be an optimal solution.
This does not mean, however, that the arts must be
profitable — only that the arts industry ought to be
structured in a way that makes it accessible to everyone.
Removing or supplementing the subsidy model would be
one way to ensure this.
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When asked what she would change about the performingarts industry in France, Irubetagoyena noted “that the door
that opens for young artists is very small” and that breaking
into the industry is difficult. In order to receive a subsidy,
a performer must have worked in the industry, but with
decreasing subsidies available, access to work becomes
more and more competitive. As such, the current model
discourages, rather than encourages, the proliferation of
performing-arts shows and is not sustainable over the long
term.
Adapting the system by opening it up to private donors
would increase the number of shows being mounted,
thereby opening the industry to more performers. This does
not mean subsidies ought to be canceled completely, but
rather that private donors should be included in the mix.
France’s performing-arts industry is fated to decline under
the current subsidy system. As noted above, this system
Growth Strategies in a Global Economy
imposes negative effects on the economy and society.
Rather than reducing costs and facilitating access, it
increases costs and limits access — paradoxically hindering
attainment of its key objectives.
Given these economic and social issues, an evolution of
France’s current cultural-funding system is unequivocally
necessary. Is France ready for a private-patron model
like that of the U.S.? Is there a new funding model that
could surpass both the private-patron and public-subsidy
systems? Much like a theatrical production, the success
of any future funding system will depend on not only the
decisions of key actors but also the interest and support of
the public.
This article was written by Joelle Birge, Chris Jones and Allegra
Richards, members of the Lauder Class of 2017.
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A GLOBAL ECONOMY